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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to ________
Commission File Number 0-25580
DIAMOND MULTIMEDIA SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0390654
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2880 JUNCTION AVENUE, SAN JOSE, CALIFORNIA 95134
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 325-7000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
The number of shares outstanding of the registrant's common
stock at April 17, 1998 was 34,767,973.
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DIAMOND MULTIMEDIA SYSTEMS, INC.
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
Page
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<S> <C>
PART I - FINANCIAL INFORMATION:
ITEM 1- Financial Statements
Consolidated Condensed Balance Sheets as of March 31, 1998
and December 31, 1997 3
Consolidated Condensed Statements of Operations for the three
months ended March 31, 1998 and 1997 4
Consolidated Condensed Statements of Cash Flows
for the three months ended March 31, 1998 and 1997 5
Notes to Consolidated Condensed Financial Statements 6
ITEM 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 8
PART II - OTHER INFORMATION
ITEM 1 - Legal proceedings 26
ITEM 2 - Changes in securities 26
ITEM 3 - Defaults Upon Senior Securities 26
ITEM 4 - Submission of Matters to a Vote of Security Holders 26
ITEM 5 - Other Information 26
ITEM 6 - Exhibits and Reports on Form 8-K 26
SIGNATURES 27
</TABLE>
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PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
DIAMOND MULTIMEDIA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 94,787 $ 85,929
Short-term investments 6,142 4,136
Trade accounts receivable, net of allowance for doubtful accounts
of $2,034 and $2,440 as of March 31, 1998 and
December 31, 1997 102,856 98,777
Inventories 92,456 78,647
Prepaid expenses and other current assets 6,958 6,350
Income taxes receivable 5,915 24,929
Deferred income taxes 13,731 14,679
--------- ---------
Total current assets 322,845 313,447
Property, plant and equipment, net 18,470 15,216
Other assets 3,416 3,616
Goodwill and other intangibles, net 5,031 5,275
--------- ---------
Total assets $ 349,762 $ 337,554
========= =========
LIABILITIES
Current liabilities:
Current portion of long-term debt $ 35,301 $ 36,455
Trade accounts payable 95,471 98,764
Accrued liabilities 20,883 17,667
Income taxes payable 5,518 2,274
--------- ---------
Total current liabilities 157,173 155,160
Long-term debt, net of current portion 1,747 1,873
--------- ---------
Total liabilities 158,920 157,033
--------- ---------
STOCKHOLDERS' EQUITY
Preferred stock, par value $.001; Authorized - 8,000 shares at March 31, 1998
and December 31, 1997; none issued and
outstanding -- --
Common stock, par value $.001;
Authorized - 75,000 at March 31, 1998 and December 31, 1997 Issued and
outstanding - 34,742 at March 31, 1998 and 34,491
at December 31, 1997 35 34
Additional paid-in capital 310,270 307,877
Distributions in excess of net book value (56,775) (56,775)
Accumulated deficit (62,688) (70,615)
--------- ---------
Total stockholders' equity 190,842 180,521
--------- ---------
Total liabilities and stockholders' equity $ 349,762 $ 337,554
========= =========
</TABLE>
The accompanying notes are an integral part of these
consolidated condensed financial statements.
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DIAMOND MULTIMEDIA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------------
1998 1997
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<S> <C> <C>
Net sales $ 186,196 $ 112,402
Cost of sales 144,570 92,817
--------- ---------
Gross profit 41,626 19,585
--------- ---------
Operating expenses:
Research and development 7,092 5,692
Selling, general and administrative 23,158 22,511
Amortization of intangibles 244 1,316
--------- ---------
Total operating expenses 30,494 29,519
--------- ---------
Income (loss) from operations 11,132 (9,934)
Interest income, net 336 543
Other expense, net (144) (55)
--------- ---------
Income (loss) before provision (benefit) for income taxes
11,324 (9,446)
Provision (benefit) for income taxes 3,397 (3,495)
--------- ---------
Net income (loss) $ 7,927 ($ 5,951)
========= =========
Net income (loss) per share:
Basic $ 0.23 $( 0.17)
Diluted $ 0.22 $( 0.17)
Shares used in per share calculations:
Basic 34,781 34,179
Diluted 36,521 34,179
</TABLE>
The accompanying notes are an integral part of these
consolidated condensed financial statements.
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DIAMOND MULTIMEDIA SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED; IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1998 1997
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 7,927 $( 5,951)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,701 2,619
Provision for doubtful accounts (54) 429
Provision for excess and obsolete inventories 4,920 556
Deferred income taxes 948 (1,660)
Changes in assets and liabilities:
Trade accounts receivables (4,025) 4,421
Inventories (18,729) (3,215)
Prepaid expenses and other assets (408) 2,003
Income taxes receivable 19,014 --
Trade accounts payable and other liabilities 3,167 (25,080)
--------- ---------
Net cash provided by (used in) operating activities 14,461 (25,878)
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment (4,711) (1,970)
Purchases of short-term investments (2,006) --
--------- ---------
Net cash used in investing activities (6,717) (1,970)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock 2,394 268
Repurchases of common stock -- (4)
Proceeds from term loans and revolving credit facilities 22,971 7,064
Payments and maturities of term loans and revolving credit
facilities (24,032) (1,365)
Repayments of capital lease financings (219) (195)
--------- ---------
Net cash provided by financing activities 1,114 5,768
--------- ---------
Net increase (decrease) in cash and cash equivalents 8,858 (22,080)
Cash and cash equivalents at beginning of period 85,929 120,147
--------- ---------
Cash and cash equivalents at end of period $ 94,787 $ 98,067
========= =========
Supplemental Disclosure of cash flow information:
Income taxes paid during the period $ 10 $ 1,400
========= =========
Interest paid during the period $ 553 $ 155
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated
condensed financial statements.
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DIAMOND MULTIMEDIA SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared by the Company in accordance with generally accepted
accounting principles for interim financial information and pursuant to rules
and regulations of the Securities and Exchange Commission. In the opinion of
management, all adjustments (consisting only of normal recurring adjustments)
considered necessary for a fair presentation have been included. These financial
statements should be read in conjunction with the Company's consolidated
financial statements and notes thereto contained in the Company's Form 10-K for
the fiscal year ended December 31, 1997.
Operating results for the quarter ended March 31, 1998 may not necessarily
be indicative of the results to be expected for any other interim period or for
the full year.
2. INVENTORIES
Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market. Inventories consisted of (in thousands):
<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
-------------- -----------------
<S> <C> <C>
Raw materials $35,550 $29,876
Work in process 45,465 40,286
Finished goods 11,441 8,485
------- -------
$92,456 $78,647
======= =======
</TABLE>
The Company had approximately $4 million of inventory in excess of its
normal short-term needs for certain product lines at March 31, 1998. Management
has developed a program to reduce this inventory to desired levels over the near
term; however, it is reasonably possible that the program will not be wholly
successful and that a material loss could ultimately result on the disposal of
this inventory. No estimate can be made of the range of amounts of such loss.
3. COMPUTATION OF NET INCOME (LOSS) PER SHARE
The Company adopted Financial Accounting Standards Board No. 128 "Earnings
Per Share" (EPS) and accordingly all prior periods have been restated. Basic EPS
is computed as net income (loss) divided by the weighted average number of
common shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur from common shares issuable through stock options,
warrants and other convertible securities. Common equivalent shares are excluded
from the computation of net loss per share as their effect is antidilutive.
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The following is a reconciliation of the numerator (net income) and
denominator (number of shares) used in the basic and diluted EPS calculation:
(Dollar amounts, in thousands)
<TABLE>
<CAPTION>
Three Months Ended March 31,
-------------------------------
1998 1997
-------- --------
<S> <C> <C>
Basic:
Net income (loss) $ 7,927 $( 5,951)
Average Common
Shares Outstanding 34,781 34,179
-------- --------
Basic EPS $ 0.23 $( 0.17)
======== ========
Diluted:
Net income (loss) $ 7,927 $( 5,951)
Average Common
Shares Outstanding 34,781 34,179
Stock options 1,740 --
Total Shares 36,521 34,179
-------- --------
Diluted EPS $ 0.22 $( 0.17)
======== ========
</TABLE>
Common equivalent shares of 1,222,000 have been excluded from the
calculation of dilituve earnings per share for the three months ended March 31,
1998 as their effect is anti-dilutive.
4. LITIGATION
The Company has been named as a defendant in several putative class action
lawsuits which were filed in June and July 1996 and June 1997 in the California
Superior Court for Santa Clara County and the U.S. District Court for the
Northern District of California. Certain executive officers and directors of the
Company are also named as defendants. The plaintiffs purport to represent a
class of all persons who purchased the Company's Common Stock between October
18, 1995 and June 20, 1996 (the "Class Period"). The complaints allege claims
under the federal securities laws and California law. The plaintiffs allege that
the Company and the other defendants made various material misrepresentations
and omissions during the Class Period. The complaints do not specify the amount
of damages sought. The Company believes that it has good defenses to the claims
alleged in the lawsuits and will defend itself vigorously against these actions.
These cases are in the early stages and no trial date has been set. The ultimate
outcome of these actions cannot be presently determined. Accordingly, no
provision for any liability or loss that may result from adjudication or
settlement thereof has been made in the accompanying consolidated financial
statements.
The Company is also party to other claims and pending legal proceedings
that generally involve employment and trademark issues. These cases are, in the
opinion of management, ordinary and routine matters incidental to the normal
business conducted by the Company. In the opinion of management, the ultimate
disposition of such proceedings will not have a materially adverse effect on the
Company's consolidated financial position or future results of operations.
5. COMPREHENSIVE NET INCOME
The Company has adopted the provisions of Statement of Financial
Accounting Standards No. 132, "Reporting Comprehensive Income", effective
January 1, 1998. This statement requires the disclosure of comprehensive income
and its components in a full set of general-purpose financial statements.
Comprehensive income is defined as net income plus revenues, expenses, gains and
losses that, under generally accepted accounting principles, are excluded from
net income. The components of comprehensive income which are
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excluded from net income are not significant, individually or in the aggregate,
and therefore, no separate statement of comprehenisve income has been presented.
6. SUBSEQUENT EVENT
On May 11, 1998 Diamond Multimedia Systems, Inc. announced that it entered
into an agreement to acquire Micronics Computers, Inc. ("Micronics") at a price
of $2.45 per share, or approximately $31.6 million, to be consummated as a cash
tender offer. Micronics is a supplier of high-performance system boards and
multimedia peripherals for personal computers. The acquisition, if completed,
will be treated as a purchase for accounting purposes and is subject to
regulatory approval and other customary conditions. The Company expects to take
a one-time charge during the second quarter in connection with the acquisition
of Micronics.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The discussion and analysis below contains trend analysis and other
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual
results could differ materially from those projected in the forward-looking
statements as a result of the risk factors set forth under "Certain Factors That
May Affect Future Performance" below and elsewhere in this report.
The following discussion should be read in conjunction with the Company's
consolidated financial statements and the notes thereto. All references to years
represent fiscal years unless otherwise noted.
OVERVIEW
Diamond Multimedia Systems, Inc. ("Diamond" or the "Company") designs,
develops, manufactures and markets multimedia and connectivity products for
IBM-compatible personal computers ("PCs"). The Company is a leading supplier of
graphics and multimedia accelerator subsystems for PCs, and is expanding its
position in the interactive multimedia market by providing advanced solutions
for home, business and professional desktop computer users, enabling them to
create, access and experience compelling new media content from their desktops
and through the Internet. Diamond accelerates multimedia from the Internet to
the hard drive with products that include the Stealth series of media
accelerators, the Monster series of entertainment 3D and audio accelerators, the
Fire series of professional 3D graphics and SCSI accelerators, and the Supra(R)
series of modems. Headquartered in San Jose, CA, Diamond has sales, marketing
and technical facilities in several locations including Vancouver (WA), Albany
(OR), Atlanta (GA), Dallas (TX), Singapore, Sydney, Hong Kong, Seoul, Tokyo,
Starnberg (Germany), Saarbrecken (Germany), Paris, and Winnersh (U.K.).
Diamond's products are sold through regional, national and international
distributors as well as directly to major computer retailers, VARs and OEMs
worldwide.
NET SALES
Net sales for the first quarter of 1998 increased $73.8 million (66%) to
$186.2 million compared to the first quarter of 1997. The increase in net sales
was primarily attributable to strong shipments of the Viper and Monster 3D
series of graphic accelerator cards as well as an increase in sales of the Fire
series of professional 3D graphics.
As a percentage of net sales, international net sales represented 46% of
net sales in the first quarter of 1998 compared to 30% of net sales in the first
quarter of 1997. The increase in the percentage of international sales was
primarily due to significant increases in product shipments to Europe in the
first quarter of 1998 relative to the corresponding prior year period.
Additionally, the percentage of international net sales derived from shipments
to countries outside of Europe also increased, albeit at a slower rate than in
Europe, in the first quarter of 1998 compared to corresponding prior year
period.
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In the current transition of mainstream PC graphics subsystem
architectures from 2D graphics and the PCI bus to 3D graphics and the
accelerated graphics port (AGP), which began in 1997 and is expected to continue
through 1998, controller and memory chip selection and the timely introduction
of new products have been and will continue to be critical factors. The Company
expects that the timing and speed of the PCI-to-AGP bus transition and the
SGRAM-to-SDRAM memory transition are likely to lead to an excess inventory of
PCI and SGRAM-based products at the Company and in the distribution channel that
is likely to result in lower average selling prices, lower gross margins,
end-of-life inventory write-offs, and higher price protection charges during the
second quarter of 1998. The Company estimates and accrues for potential
inventory write-offs and price protection charges. However, there can be no
assurance that these estimates and accruals will be sufficient, and additional
inventory write-offs and price protection charges may be required, the result of
which could have a material effect on operating results during the second
quarter of 1998.
Inventory levels of the Company's products in the two-tier distribution
channels used by the Company ("Channel Inventory Levels") generally are
maintained in a range of one to three months of customer demand. These Channel
Inventory Levels tend toward the low end of the months-of-supply range when
demand is stronger, sales are higher and products are in short supply.
Conversely, when demand is slower, sales are lower and products are abundant,
then Channel Inventory Levels tend toward the high end of the months-of-supply
range. Frequently, in such situations, the Company attempts to ensure that
distributors devote their working capital, sales and logistics resources to the
Company's products to a greater degree than to those of competitors. Similarly,
the Company's competitors attempt to ensure that their own products are
receiving a disproportionately higher share of the distributors' working capital
and logistics resources. In an environment of slower demand and abundant supply
of products, price declines are more likely to occur and, should they occur, are
more likely to be severe. Further, in such an event, high Channel Inventory
Levels may result in substantial price protection charges. Such price protection
charges have the effect of reducing net sales and gross profit. Consequently,
the Company, in taking steps to bring its Channel Inventory Levels down to a
more desirable level, may cause a shortfall in net sales during one or more
accounting periods. This situation may also result in price protection charges
as prices are decreased, having an adverse impact on operating results. While
the Company believes that its Channel Inventory Levels for many of its products
are appropriate at this time, there are certain products which currently have a
Channel Inventory Level that is higher than desirable. The Company accrues for
potential price protection on unsold channel inventory. However, there can be no
assurance that these estimates or accruals will be sufficient. Should the
estimates or accruals not be sufficient, additional price protection charges may
be required, the result of which could have a material adverse effect on
operating results during the second quarter of 1998.
GROSS MARGIN
Gross profit for the first quarter of 1998 increased $22.0 million to
$41.6 million compared to $19.6 million in the first quarter of 1997. Gross
margin (gross profit as a percentage of net sales) increased to 22.4% of net
sales during the first quarter of 1998 from 17.4% for the first quarter of 1997.
The increase was primarily due to the relatively high margin obtained from the
Company's Viper, Monster 3D and Fire GL series of graphic accelerator cards,
which experienced strong shipments in the first quarter of 1998. Further, the
gross margin was positively impacted by significantly higher shipment volume
levels over which indirect manufacturing costs could be absorbed.
RESEARCH AND DEVELOPMENT
Research and development (R&D) expenses increased $1.4 million (25%) to
$7.1 million for the first quarter of 1998, compared to the corresponding period
in 1997. This increase was primarily due to higher personnel-related expenses
and the material and outside service costs associated with new product
development, including products that will offer various functions or
combinations of functions including graphics, digital video, 3D animation, 3D
CAD, sound, modem, telephony and other functions increasingly being implemented
on personal computers. As a percentage of sales, R&D expenses were 3.8% and 5.1%
in the first quarter of 1998 and 1997, respectively. The decrease in expenses as
a percentage of net sales is primarily attributable to the increase in net sales
during the first quarter of 1998 compared to the first quarter of 1997.
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SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative (SG&A) expenses increased $0.6 million
(3%) to $23.2 million for the first quarter of 1998 compared to the first
quarter of 1997. This increase in expense was partially offset by a decline in
sales and promotional expenses, including fewer expenses attributable to channel
sales incentive programs during the first quarter of 1998 compared to the first
quarter of 1997. As a percentage of sales, SG&A expenses were 12.4% and 20.0% in
the first quarter of 1998 and 1997, respectively. The decrease in expenses, as a
percentage of sales, is primarily from the increase in net sales during the
first quarter of 1998 compared to the corresponding period of 1997.
AMORTIZATION OF INTANGIBLE ASSETS
The Company incurred amortization expense of $0.2 million in the first
quarter of 1998 compared to $1.3 million in the corresponding prior year period.
The decrease in expense in the first quarter of 1998 is primarily due to the
write-off of $9.9 million of intangible assets during the second quarter of 1997
which significantly reduced the remaining outstanding balance to be amortized.
These expenses relate to amortization of purchased technology and goodwill from
the Supra Corporation and SPEA Software AG acquisitions, which occurred in the
third and fourth quarters of 1995, respectively. This decrease in expense was
offset in part by amortization expense arising from the $2 million of goodwill
created by Company's acquisition of Binar Graphics, Inc. which occurred in
November 1997.
NET INTEREST INCOME (EXPENSE) AND OTHER EXPENSE
Net interest income was $0.3 million and $0.5 million in the first quarter
of 1998 and 1997, respectively. Net interest income declined due to higher
interest expense incurred because of larger average borrowings outstanding
during the first quarter of 1998 compared to the first quarter of 1997. Other
expense remained relatively flat during the first quarters of 1998 and 1997.
PROVISION (BENEFIT) FOR INCOME TAXES
The Company's effective tax rate in the first quarter of 1998 was 30%
compared to an income tax benefit rate of 37% for the corresponding period in
1997 when a pre-tax loss was incurred. Differences from the statutory rate
consisted principally of the effect of state income taxes, federal tax-exempt
interest income and the research and development tax credit.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased by $8.9 million during the first
quarter of 1998. Operating activities provided $14.5 million in cash, and the
primary sources of cash were as follows: net income of $7.9 million; a decrease
in income taxes receivables and a decrease in trade accounts payable and other
liabilities of $19.0 million and $3.2 million, respectively, and depreciation
and amortization expense of $1.7 million. These sources of cash from operating
activities were offset in part by an increase in inventories, net of the
provision for obsolescence, of $13.8 million, and an increase in trade
receivables, net of the provision for doubtful accounts of $4.0 million.
The Company used $6.7 million in cash from investing activities for the
purchase of property and equipment of $4.7 million and purchases of short-term
investments of $2.0 million. Net cash provided by financing activities was $1.1
million, primarily due to proceeds of $23.0 million from term loans and
revolving credit facilities and proceeds of $2.4 million from the issuance of
common stock. These proceeds were partially offset by payments and maturities of
term loans and revolving credit facilities of $24.0 million.
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At March 31, 1998, the Company had $94.8 million of cash and cash
equivalents and $6.1 million of short-term investments. Further, as of such
date, the Company had lines of credit and bank credit facilities totaling $61.2
million, of which $24.2 million was unused and available.
The Company expects to spend approximately $12 million for capital
equipment in 1998, principally relating to computer and office equipment and
including, in particular, an enhanced enterprise-wide business management,
resource planning and decision support application.
On May 11, 1998 Diamond Multimedia Systems, Inc. announced that it entered
into an agreement to acquire Micronics Computers, Inc. ("Micronics") at a price
of $2.45 per share, or approximately $31.6 million, to be consummated as a cash
tender offer. Micronics is a supplier of high-performance system boards and
multimedia peripherals for personal computers. The acquisition, if completed,
will be treated as a purchase for accounting purposes and is subject to
regulatory approval and other customary conditions. The Company expects to take
a one-time charge during the second quarter in connection with the acquisition
of Micronics.
The Company believes that its cash balances and available credit under
existing bank lines will be sufficient to meet anticipated operating and
investing requirements for the short term. There can be no assurance that
additional capital beyond the amounts currently forecasted by the Company will
not be required nor that any such required additional capital will be available
on reasonable terms, if at all, at such time or times as required by the
Company.
CERTAIN FACTORS THAT MAY AFFECT FUTURE PERFORMANCE
In addition to other information in this Form 10-Q, the following are
important factors that should be considered carefully in evaluating the Company
and its business.
POTENTIAL FLUCTUATIONS IN FUTURE OPERATING RESULTS
The Company's operating results have fluctuated significantly in the past
on a quarterly and an annual basis and is likely to continue to fluctuate
significantly in the future depending on a number of factors. The accompanying
sections explain in greater detail certain important factors that the Company
has identified which may affect the future performance of the Company.
The Company develops products in the highly competitive multimedia
graphics, video, sound, modem and SCSI adapter markets. These products are very
susceptible to product obsolescence and typically exhibit a high degree of
volatility of shipment volumes over their relatively short product life cycles.
The timing of introductions of new products in one calendar quarter as opposed
to an adjacent quarter can materially affect the relative sales volumes in those
quarters. In addition, product releases by competitors and accompanying pricing
actions can materially and adversely affect the Company's revenues and gross
margins.
Similarly, the Company sells its products to retail customers (mass
merchandisers and large chains who sell products primarily off-the-shelf
directly to end users) retail distribution customers (distributors which resell
to smaller retail chains and large individual end users) and OEM customers
(customers which use the Company's products in conjunction with other products
to produce complete computer systems for sales through both direct and indirect
distribution channels to end users). Reliance on these customers for almost all
of the Company's sales means that the Company typically has little or no direct
visibility into end user customer demand. OEM customers tend to provide the
Company with forecasts for product requirements but actual order lead times
remain less than 90 days. Retail and retail distribution customers typically do
not forecast product requirements and order lead times are typically very short,
as these customers tend to reorder for stock in quantities that approximate
recent sales volumes. Accordingly, this means that future operating results are
dependent on continued sales to customers where the vast majority of the normal
volume of orders are placed with the Company within the same calendar quarter as
the requested date of shipment by the customer.
Because the lead times of firm orders are typically short, the Company does
not have the ability to predict with any certainty the future operating results
of the Company. Therefore, sudden changes that are out of the control of the
Company such as general economic conditions, the actions or inaction of
competitors, customers, third party vendors of operating system software,
central processing unit hardware, and independent software application vendors
can have and have had material adverse effects on the Company's performance.
Other factors which may have a material adverse effect on the Company's
future performance, include the management of growth of the Company, latent
defects that can exist in the Company's products, competition for
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the available supply of components, dependence on subcontract manufacturers,
dependence on and development of adequate information technology systems,
intellectual property rights and dependence on key personnel.
Each of these factors is discussed more thoroughly in the accompanying
sections and all of these sections should be read carefully together to evaluate
the risks associated with the Company's Common Stock. Due to these factors, it
is likely that the operating results of the Company in some future quarter or
quarters will fall below the expectations of securities analysts and investors.
In such an event, the trading price of the Company's Common Stock could be
materially and adversely affected.
REVENUE VOLATILITY AND DEPENDENCE ON ORDERS RECEIVED AND SHIPPED IN A QUARTER
The volume and timing of orders received during a quarter are difficult to
forecast. Retail and retail distribution customers generally order without
forecasts on an as-needed basis and, accordingly, the Company has historically
operated with a relatively small backlog. Moreover, the Company has emphasized
its ability to respond quickly to customer orders as part of its competitive
strategy. This strategy, combined with current industry supply and demand
conditions as well as the Company's emphasis on minimizing inventory levels, has
resulted in customers placing orders with relatively short delivery schedules
and increased demand on the Company to carry inventory for its customer base.
This has the effect of increasing such short lead time orders as a portion of
the Company's business and reducing the Company's ability to accurately forecast
net sales. Because retail and retail distribution customers' orders are more
difficult to predict, there can be no assurance that the combination of these
orders, OEM's orders, and backlog in any quarter will be sufficient to achieve
either sequential or year-over-year growth in net sales during that quarter. If
the Company does not achieve a sufficient level of retail and retail
distribution orders in a particular quarter, the Company's revenues and
operating results would be materially adversely affected.
Also, at any time and with no advance notice, during periods of
uncertainty in the personal computer industry's outlook for future demand or
pricing, the Company's customers may choose to draw down their inventory levels
thereby adversely impacting the Company's revenue during the period of
adjustment. The second and third quarters of 1997 comprised such a period due to
the transition from older slower speed modems and 2D graphics products to new
higher speed modems and 3D graphics products. In the current transition of
mainstream PC graphics subsystem architectures from 2D graphics and the PCI bus
to 3D graphics and the accelerated graphics port (AGP), which began in 1997 and
is expected to continue through 1998, controller and memory chip selection and
the timely introduction of new products have been and will continue to be
critical factors. The Company expects to see the effects of the PCI-to-AGP
transition and the SGRAM-to-SDRAM memory transition in the second quarter of
1998, which will result in significant pricing pressures on the Company's
remaining PCI-based and SGRAM-based graphics inventory and the inventory of such
products in the distribution channel. As a result, the net sales and gross
margins of the Company are likely to be materially and adversely affected by
declining prices for the PCI-based and SGRAM-based products and any significant
price protection claims associated with such price declines. Also, as is common
in the personal computer industry, a disproportionate percentage of the
Company's net sales in any quarter may be generated in the last month or weeks
of a quarter. As a result, a shortfall in sales in any quarter as compared to
expectations may not be identifiable until at or near the end of the quarter. In
addition, from time to time, a significant portion of the Company's net sales
may be derived from a limited number of customers, the loss of one or more of
which could adversely impact operating results.
Notwithstanding the difficulty in forecasting future sales and the
relatively small level of backlog at any given time, the Company generally must
plan production, order components and undertake its development, sales and
marketing activities and other commitments months in advance. Accordingly, any
shortfall in net sales in a given quarter may materially impact the Company's
operating results and cash balances in a magnified way due to the Company's
inability to adjust expenses or inventory levels during the quarter to match the
level of net sales for the quarter. Excess inventory could also result in cash
flow difficulties as well as added costs of goods sold and expenses associated
with inventory write-offs or sell-offs. Conversely, in its efforts to adjust
inventory levels to a slower order rate, the Company may overcorrect its
component purchases and inventory levels, thereby experiencing periodic
shortages of inventory and delivery delays, and negatively impacting its net
sales,
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market share and customer satisfaction levels in the current quarter or in
future quarters. There can be no assurances that such an occurrence will not
adversely impact the Company operating results.
DECLINING SELLING PRICES AND OTHER FACTORS AFFECTING GROSS MARGINS
The Company's markets are characterized by intense ongoing competition and
coupled with a past history and a current trend of declining average selling
prices. A decline in selling prices may cause the net sales in a quarter to be
lower than the revenue of a preceding quarter or corresponding prior year's
quarter even if more units were sold during such quarter than in the preceding
or corresponding prior year's quarter. Accordingly, it is likely that the
Company's average selling prices will decline, and that the Company's net sales
and margins may decline in the future, from the levels experienced to date. (See
also Short Product Life Cycles; Dependence on New Products) The Company's gross
margins may also be adversely affected by shortages of, or higher prices for,
key components for the Company's products, including its modems, 3D graphics
accelerators, SCSI I/O host bus adapters and 3D audio accelerators products,
some of which have been impacted from time-to-time by a scarcity in the supply
of associated chipsets and other components. For example, the recent agreement
by Symbios (the sole supplier of the Company's SCSI controllers) to be acquired
by Adaptec (the Company's chief competitor in the SCSI host bus adapter card
market) may, if such acquisition is consummated, result in the unavailability of
SCSI controllers for the Company's SCSI products, or the unavailability of such
controllers or software support under economically reasonable prices, terms,
conditions or timing. Additionally, the acquisition, if consummated, may lead to
caution or reluctance on the part of the Company's customers or potential
customers, both direct and indirect, to do business with Adaptec's competitors
who have historically used Symbios controllers.
In addition, the Company's net sales, average selling prices and gross
margins will be adversely affected if the market prices for certain components
used or expected to be used by the Company, such as DRAM, SDRAM, SGRAM or RDRAM
memory, DVD drives, multimedia controller chips or bundled software, decline
more rapidly than the Company is able to process component inventory bought
earlier at higher prices into finished products, book and ship the related
orders, and move such products through third-party distribution channels, some
of which may be price protected, to the final customer. For example, operating
results were negatively impacted in the second and third quarters of 1996 by
declining market prices for the Company's products, caused in part by a sharp
reduction in the market price for DRAMs. The Company might experience such
declining prices and tighter margins in the second quarter of 1998 due to the
effect of product transitions, including the PCI-to-AGP transition and the
SGRAM-to-SDRAM memory transition. Conversely, an increase in the price of
semiconductor components that are in scarce supply, such as high-speed DRAMs,
may adversely impact the Company's gross margin due to higher unit costs, and a
decrease in the supply of such semiconductor components may adversely impact the
Company's net sales due to lower unit shipments.
SEASONALITY
The Company believes that, due to industry seasonality, demand for its
products is strongest during the fourth quarter of each year and is generally
slower in the period from April through August. This seasonality may become more
pronounced and material in the future to the extent that a greater proportion of
the Company's sales consist of sales into the retail/mass merchant channel, that
PCs become more consumer-oriented or entertainment-driven products, or that the
Company's net sales becomes increasingly based on entertainment-centric
products. Also, to the extent the Company is successful in expanding its
European operations, it may experience relatively weak demand in third calendar
quarters due to historically weak summer sales in Europe.
MANAGEMENT OF GROWTH
In recent years, the Company has experienced a significant expansion in the
overall level of its business and the scope of its operations, including
manufacturing, research and development, marketing, technical support, customer
service, sales and logistics. In addition, through its acquisitions of Supra in
September 1995 and Spea in November 1995, the Company increased the scope of its
product lines and multinational operations. This expansion in scope has resulted
in a need for significant investment in infrastructure, processes and
information systems, as well as the integration of the operations of Supra and
Spea into the Company's infrastructure. This
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requirement includes, without limitation: Securing adequate financial resources
to successfully integrate and manage the acquired businesses; retention of key
employees; integration of management information, product data management,
control and telecommunications systems; consolidation of geographically
dispersed manufacturing and distribution facilities; consolidation and
coordination of suppliers; rationalization of distribution channels;
establishment and documentation of business processes; and integration of
various functions and groups of employees. Each of these requirements poses
significant, material challenges. For example, the Company established a
restructuring reserve in the second quarter of 1997 to account for the expected
expenses of, among other actions, integrating customer service and distribution
from Supra into Diamond, transitioning manufacturing from Supra's facility in
Oregon to a subcontractor facility in Mexico, and integrating technical support
from Diamond's San Jose, California facility to Supra's technical support
organization in Oregon. Moreover, Spea historically has not been profitable and
the Company's management took significant steps to reduce expenses at Spea and
integrate its operations with those of the Company. Accordingly, the Company
reorganized Spea to function principally as follows: a product localization and
marketing operation for Europe; a sales, technical support and customer service
operation for Central Europe; and a product development and launch facility for
professional 3D graphics, including CAD and digital animation, for the Company's
worldwide markets. The Company discontinued manufacturing, test, packaging and
logistics operations at Spea effective October 1, 1996. Prior to its acquisition
by the Company, Spea made certain investments including entering into the shared
ownership (at 49.5%) with Philips Semiconductor (at 50.5%) of a 3D graphics
semiconductor design subsidiary, SP3D. The Company's 49.5% ownership of SP3D is
carried on the Company's balance sheet at approximately $3.4 million. Philips
Semiconductor has full day-to-day operating management control of SP3D and holds
the majority of seats on the SP3D board. There can be no assurance that the
Company will be able to achieve a reasonable return on this asset, or that the
asset will not need to be written down, in whole or in part, during subsequent
accounting periods.
The Company's future operating results will depend in large measure on its
success in implementing operating, manufacturing and financial procedures and
controls, improving communication and coordination among the different operating
functions, integrating certain functions such as sales, procurement and
operations, strengthening management information and telecommunications systems,
and continuing to hire additional qualified personnel in all areas. Moreover,
the Company has selected and is implementing a new enterprise resource planning
(ERP) system to be fully operational in late 1998 in order to properly manage
the increasing complexity of its international multi-product business and avert
potential Year 2000 issues with its current management information system. There
can be no assurance that the Company will be able to manage these activities and
implement these additional systems, procedures and controls successfully, and
any failure to do so could have a material adverse effect upon the Company's
short-term and long-term operating results.
SHORT PRODUCT LIFE CYCLES; DEPENDENCE ON NEW PRODUCTS
The market for the Company's products is characterized by frequent new
product introductions and rapid product obsolescence. These factors typically
result in short product life cycles, frequently ranging from six to twelve
months. The Company must develop and introduce new products in a timely manner
that compete effectively on the basis of price and performance and that address
customer needs and meet customer requirements. To do this, the Company must
continually monitor industry trends and make difficult choices regarding the
selection of new technologies and features to incorporate into its new products,
as well as the timing of the introduction of such new products, all of which may
impair the orders for or the prices of the Company's existing products. The
success of new product introductions depends on various factors, some of which
are outside the Company's direct control. Such factors may include: selection of
new products; selection of controller or memory chip architectures; timely
completion and introduction of new product designs; trade-offs between the time
of first customer shipment and the optimization of software for speed, stability
and compatibility; development of supporting content by independent software
application vendors; development and production of collateral product
literature; prompt delivery to OEM accounts of prototypes; support of OEM
prototypes; ability to rapidly ramp manufacturing volumes; and coordination of
advertising, press relations, channel promotion and VAR evaluation programs.
In the current transition of mainstream PC graphics subsystem
architectures from 2D graphics and the PCI bus to 3D graphics and the
accelerated graphics port (AGP), which began in 1997 and is expected to continue
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through 1998, controller and memory chip selection and the timely introduction
of new products have been and will continue to be critical factors. The Company
expects to see the effects of the PCI-to-AGP transition and the SGRAM-to-SDRAM
memory transition in the second quarter of 1998, which will result in
significant pricing pressures on the Company's remaining PCI-based and
SGRAM-based graphics inventory and the inventory of such products in the
distribution channel. As a result, the net sales and gross margins of the
Company are likely to be materially and adversely affected by declining prices
for the PCI-based and SGRAM-based products and any significant price protection
claims associated with such price declines. In addition, in the current
transition from the widely accepted V.34 modem protocol (33.6Kbps) through the
new higher speed proprietary K56flex and x2 protocols (56Kbps) to the new
international standard V.90 protocol (56Kbps), the chip selection to implement
and deploy such a standard and the industry alliances to convert such support
into revenue and market share have been and will continue to be critical
factors. There can be no assurance that the Company will select the proper chips
to implement and support its efforts in the various markets or that the Company
will execute its strategy in a timely manner during this transition period.
Each new product cycle presents new opportunities for current or
prospective competitors of the Company to gain a product advantage or increase
their market share. If the Company does not successfully introduce new products
within a given product cycle, the Company's sales will be adversely affected for
that cycle and possibly for subsequent cycles. Any such failure could also
impair the Company's brand name and ability to command retail shelf space and
OEM design wins in future periods. Moreover, because of the short product life
cycles coupled with the long lead times for procuring many of the components
used in the Company's products, the Company may not be able, in a timely manner,
or at all, to reduce its component procurement commitments, software license
commitments, production rates or inventory levels in response to unexpected
delays in product launch, shortfalls in sales, technological obsolescence or
declines in prices or, conversely, to increase production in response to
unexpected increases in demand, particularly if such demand increases are in a
new product or new technology area where component supply may be hard to secure.
Therefore, changes in actual or expected demand could result in excess
inventory, inventory write downs, price protection and gross margin compression
or, conversely, in lost sales and revenue compression due to product or
component unavailability. The Company expects that the timing and speed of the
PCI-to-AGP bus transition and the SGRAM-to-SDRAM memory transition are likely to
lead to an excess inventory of PCI and SGRAM-based products at the Company and
in the distribution channel that is likely to result in lower average selling
prices, lower gross margins and higher price protection charges during the
second quarter of 1998. The Company estimates and accrues for potential
inventory write-offs and price protection charges. However, there can be no
assurance that these estimates and accruals will be sufficient, and additional
inventory write-offs and price protection charges may be required, the result of
which could have a material effect on operating results during the second
quarter of 1998.
NEW OPERATING SYSTEMS
The PC industry has been characterized by significant operating system
changes, such as the introduction of Windows 95 in 1995 and Windows NT 4.0 in
1996, and the introduction of significant new operating system components, such
as Microsoft's Direct X and ActiveX for Windows 95. While new operating systems
can provide new market opportunities, such as the growing market for graphical
user interface (GUI) accelerators that occurred with the introduction of Windows
3.0 and the growth in the PC games market with the introduction of Windows 95,
new operating systems and operating system components also place a significant
research and development burden on the Company. New drivers, applications and
user interfaces must be developed for new operating systems and operating system
components in order to maintain net sales levels and customer satisfaction.
Perhaps more significantly, such drivers, applications and interfaces
customarily are ported to the recently shipped portion of the Company's
installed base. This effort involves a substantial software engineering,
compatibility testing and customer technical support investment with only
limited near-term incremental revenue return since these driver updates are
usually provided via electronic distribution at no cost to the Company's
installed customer base. In addition, the installation of this software may
result in technical support calls, thereby generating expenses that do not have
offsetting revenue. Moreover, during the introductory period of a major new
operating system release such as Windows 95, such installed base support may
reduce the research and development and customer technical support resources
available for launching new products. For example, after substantial investment
in porting the Company's software, graphics accelerator and modem products to
Windows 95, the Company was at year-end 1996 still developing for final release
improved, accelerated Windows 95 drivers for the Viper Pro Video series of
accelerator add-in cards. While this product line did not at that time represent
a revenue opportunity for the Company, the Company nevertheless believed that it
was important to make the significant software development investment
represented by this effort in order to maintain relations with its installed
customer base and its reputation for reliable on-going product support.
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Furthermore, new operating systems for which the Company prospectively develops
driver support may not be successful, or the drivers themselves may not be
successful or accepted by customers, and a reasonable financial return on the
corollary research and development investment may never be achieved.
Microsoft has announced that it expects to release for initial end-user
shipment in June 1998 a new operating system, Windows 98, an upgrade to the
Windows 95 operating system. The Company expects that there will be hesitation
on the part of end users to purchase new computer equipment incorporating
Windows 95 as the date of the introduction of Windows 98 nears, and possibly for
a period of time immediately following such introduction. If an unusually large
number of customers delay purchase of new systems, or add-on multimedia
peripherals, such a delay could affect the short term timing of the sales of the
Company which may have a negative effect on the Company's results in the second
and third quarters of 1998.
DEPENDENCE ON THIRD PARTY SOFTWARE DEVELOPERS
The Company's business strategy includes developing relationships with
major independent software application vendors that serve the 3D graphics and 3D
audio markets, including the 3D computer games market and the professional 3D
graphics market. The Company believes that the availability of a sufficient
number of high quality, commercially successful entertainment 3D software titles
will be a significant factor in the sale of multimedia hardware to the PC-based
interactive 3D entertainment market. The Company also believes that compelling
professional 3D graphics applications developed for PCs or ported from
traditional workstations, such as those supplied by Silicon Graphics and Sun
Microsystems, to PCs based on advanced Intel microprocessors and the Microsoft
NT operating system will be significant factors in the sale of 3D graphics
hardware to the PC-based NT workstation market. The Company depends on
independent software application developers and publishers to create, produce
and market software entertainment titles and professional graphics applications
that will operate with the Company's 3D products, such as Monster, Stealth,
Viper and Fire GL. Only a limited number of software developers are capable of
creating high quality professional 3D and entertainment 3D software. Competition
for these resources is intense and is expected to increase. There can be no
assurance that the Company will be able to attract the number and quality of
software developers and publishers necessary to develop a sufficient number of
high quality, commercially successful software titles and applications that are
compatible with the Company's 3D products.
Further, in the case of the Company's entertainment 3D products, there can
be no assurance that third parties will publish a substantial number of
entertainment 3D software titles or, if entertainment 3D software titles are
available, that they will be of high quality or that they will achieve market
acceptance. The development and marketing of game titles that do not fully
demonstrate the technical capabilities of the Company's entertainment 3D
products could create the impression that the Company's products offer less
compelling performance over competing 3D games platforms, such as TV games
console platforms. This may slow or stop any migration from the current
widespread use of TV games consoles to the use of computer games on PCs, or the
enhancement of PCs to operate such games. Further, because the Company has no
control over the content of the entertainment titles produced by software
developers and publishers, the entertainment 3D software titles developed may
represent only a limited number of game categories and are likely to be of
varying quality.
SEMICONDUCTOR OR SOFTWARE DEFECTS
Product components may contain undetected errors or "bugs" when first
supplied to the Company that, despite testing by the Company, are discovered
only after certain of the Company's products have been installed and used by
customers. There can be no assurance that errors will not be found in the
Company's products due to errors in such products' components, or that any such
errors will not impair the market acceptance of these products or require
significant product recalls. Problems encountered by customers or product
recalls could materially adversely affect the Company's business, financial
condition and results of operations. Further, the Company continues to upgrade
the firmware, software drivers and software utilities that are incorporated into
or included with its hardware products. The Company's software products, and its
hardware products incorporating such software, are extremely complex due to a
number of factors including the products' advanced functionality, the diverse
operating environments in which the products may be deployed, the need for
interoperability, and the multiple versions of such products that must be
supported for diverse operating
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platforms, languages and standards. These products may contain undetected errors
or failures when first introduced or as new versions are released. The Company
generally provides a five-year warranty for its products and, in general, the
Company's return policies permit return within thirty days after receipt of
products that do not meet product specifications. There can be no assurance
that, despite testing by the Company, by its suppliers and by current or
potential customers, errors will not be found in new products after commencement
of commercial shipments, resulting in loss of or delay in market acceptance or
product acceptance or in warranty returns. Such loss or delay would likely have
a material adverse effect on the Company's business, financial condition and
results of operations.
Additionally, new versions or upgrades to operating systems or
independent software vendor titles or applications may require upgrades to the
Company's software products to maintain compatibility with these new versions or
upgrades. There can be no assurance that the Company will be successful in
developing new versions or enhancements to its software or that the Company will
not experience delays in the upgrade of its software products. In the event that
the Company experiences delays or is unable to maintain compatibility with
operating systems and independent software vendor titles or applications, the
Company's business, financial condition and results of operations could be
materially adversely affected.
MARKET ANTICIPATION OF NEW PRODUCTS, NEW TECHNOLOGIES OR LOWER PRICES
Since the environment in which the Company operates is characterized by
rapid new product and technology introductions and generally declining prices
for existing products, the Company's customers may from time to time postpone
purchases in anticipation of such new product introductions or lower prices. If
such anticipated changes are viewed as significant by the market, such as the
introduction of a new operating system or microprocessor architecture, then this
may have the effect of temporarily slowing overall market demand and negatively
impacting the Company's operating results. For example, the substantial
pre-release publicity surrounding the release of Windows 95 may have contributed
to a slowing of the consumer PC market in the summer of 1995. Moreover, a
similar reaction has likely occurred in the modem market as a result of the
announcements of modems based on 56 Kbps technology which became available in
1997, or in the overall PC market in anticipation of Intel Corporation's
transition to MMX-based microprocessors during 1997. Additionally, the
substantial publicity by Intel Corporation for its MMX technology may have
confused and slowed the market for add-in multimedia accelerators, such as those
sold by the Company, during the first half of 1997. If so, these effects may
continue into future periods for these or similar events. Other anticipated new
product releases that may influence future market growth or the timing of such
growth include Microsoft's expected release of its Windows 98 operating system
in June 1998, Intel's release of its Pentium II CPU and the associated chipsets
supporting the AGP and 2x AGP architectures, and Intel's release of its "Merced"
workstation CPU slated for first customer shipment in 1999.
The potential negative impact on the Company's operating results as a
result of customer decisions to postpone purchases in favor of new and
"publicized" technology can be further magnified if products or components based
on such new technology are not available in a timely manner or in sufficient
supply to meet the demand caused by the market's shift to the new technology
from an older technology. For example, the Company believes that the PC market
may have slowed in early 1997 in part as customers waited for the availability
of Intel's new MMX-enabled Pentium CPUs. Further, the Company's operating
results could be adversely affected if the Company makes poor selections of chip
architectures or chip suppliers to pursue 3D graphics, AGP or 56Kbps modem
market opportunities and, as a result, is unable to achieve market acceptance of
its new products or is unable to secure enough supply of such components.
If the Company or any of its competitors were to announce a product that
the market viewed as having more desirable features or pricing than the
Company's existing products, demand for the Company's existing products could be
curtailed, even though the new product is not yet available. For example, the
Company's next-generation eight-megabyte SDRAM-based graphics accelerators, due
to commence shipment in the second quarter of 1998, has a memory cost component
roughly equivalent to four-megabyte SGRAM-based graphics accelerators. There can
be no assurance that market anticipation of this new product release or similar
competitive releases will not reduce demand for the Company's current graphics
products and materially and adversely affect the Company's operating results for
the second quarter of 1998. Similarly, if the Company's
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customers anticipate that the Company may reduce its prices in the near term,
they might postpone their purchases until such price reductions are effected,
reducing the Company's near-term shipments and revenue. In general, market
anticipation of new products, new technologies or lower prices, even though
potentially positive in the longer term, can negatively impact the Company's
operating results in the short term.
COMPONENT SHORTAGES; RELIANCE ON SOLE OR LIMITED SOURCE SUPPLIERS
The Company is dependent on sole or limited source suppliers for certain
key components used in its products, particularly chipsets that provide
graphics, digital video, DVD, television (TV), sound or other multimedia
functions, random access memory (including DRAM, RDRAM, SDRAM and SGRAM) chips,
and speakerphone modem and fax/modem chipsets. Although the price and
availability of many semiconductor components improved during 1996 and 1997,
these components are periodically in short supply and on allocation by
semiconductor manufacturers. For example, it is expected that the Company may
experience substantial constraints in the supply of high-performance SGRAMs and
high-performance 3D graphics chips for the foreseeable future. There can be no
assurances that the Company can obtain adequate supplies of such components, or
that such shortages or the costs of these components will not adversely affect
future operating results. The Company's dependence on sole or limited source
suppliers, and the risks associated with any delay or shortfall in supply, can
be exacerbated by the short life cycles that characterize multimedia and
communications ASIC chipsets and the Company's products in general. Although the
Company maintains ongoing efforts to obtain required supplies of components,
including working closely with vendors and qualifying alternative components for
inclusion in the Company's products, component shortages continue to exist from
time to time, and there can be no assurances that the Company can continue to
obtain adequate supplies or obtain such supplies at their historical or
competitive cost levels. Conversely, in its attempt to counter actual or
perceived component shortages, the Company may overpurchase certain components,
resulting in excess inventory and reducing the Company's liquidity or, in the
event of unexpected inventory obsolescence or a decline in the market value of
such inventory, causing inventory write-offs or sell-offs that adversely affect
the Company's gross margin and profitability. In addition, such inventory
sell-offs by the Company or its competitors could trigger channel price
protection charges, further reducing the Company's gross margins and
profitability.
As noted above, supply and demand conditions for semiconductor components
are unpredictable and may change from time to time. During periods of
oversupply, prices are likely to fall and certain vendors of such semiconductor
chips may liquidate their inventories in a rapid manner. If such semiconductor
vendors are suppliers to the Company's competitors, then such actions could
enable competitors of the Company to enjoy a cost advantage vis-a-vis the
Company, and any resultant price reduction for such competitors' products could
force the Company to reduce its prices, thereby depressing the Company's net
sales and gross margins in one or more operating periods. For example, the
recent agreement by Symbios (the sole supplier of the Company's SCSI
controllers) to be acquired by Adaptec (the Company's chief competitor in the
SCSI host bus adapter card market) may, if such acquisition is consummated,
result in the unavailability of SCSI controllers for the Company's SCSI
products, or the unavailability of such controllers or software support under
economically reasonable prices, terms, conditions or timing. Additionally, the
acquisition, if consummated, may lead to caution or reluctance on the part of
the Company's customers or potential customers, both direct and indirect, to do
business with Adaptec's competitors who have historically used Symbios
controllers.
During periods of component oversupply and associated price deflation,
customers of the Company, particularly those comprising channels that do not
receive price protection from the Company, may seek to draw down the inventory
that they hold since such inventory likely would bear a price deflation risk. As
a consequence, the Company may see its orders, unit shipments or average selling
prices depressed from time to time during such price-deflation and
inventory-reduction periods, including potentially the second quarter of 1998,
which could adversely affect net sales and gross margin in the related operating
period or periods.
When the PC or PC peripherals markets emerge from a period of oversupply,
such as that experienced in the second quarter of 1997, certain manufacturers,
distributors and resellers may be unprepared for a possible rapid increase in
market demand. Accordingly, the Company may not have sufficient inventory,
scheduled component purchase orders or available manufacturing capacity to meet
any rapid increase in market demand,
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thereby missing orders and revenue opportunities, causing customer
dissatisfaction and losing market share. The Company experienced such a
situation in the second half of 1997 and in the first quarter of 1998 as the
Company experienced a shortage of various components, restricting the Company's
ability to manufacture quantities of certain products in sufficient quantities
or in a linear fashion during the quarter to meet market demand. For certain
products, the Company continues to experience such restrictions in the second
quarter of 1998. In addition, the Company believes that in the near term the
Company will continue to be subjected to restricted supply and increasing prices
on certain semiconductor components including certain graphics controllers and
memories. The inability of the Company to obtain product components at their
historical or planned cost levels, resulting in the Company being forced to pay
higher prices to achieve timely delivery, would directly affect the cost of the
Company's products and could materially and adversely affect the Company's gross
margin. There can be no assurance that the Company will be able to obtain
adequate supplies of components or that such shortages or the costs of these
components will not adversely impact the Company's future operating results.
Conversely, there can be no assurance that the Company will not see the value of
its inventory depreciate if components in a shortage condition emerge from that
condition and experience a significant oversupply condition. For example, this
situation may occur during the second quarter of 1998 with certain graphics
chips that support only SGRAM memory.
DEPENDENCE ON SUBCONTRACTORS
The Company relies on independent surface mount technology ("SMT") and
printed circuit board ("PCB") subcontractors to manufacture, assemble or test
the Company's products. The Company typically procures its components, assembly
and test services and assembled products through purchase orders and does not
have specific volume purchase agreements with each of its subcontractors. Most
of the Company's subcontractors could cease supplying the services, products or
components at any time with limited or no penalty. In the event that it becomes
necessary for the Company to replace a key subcontractor, the Company could
incur significant manufacturing set-up costs and delays. There can be no
assurance that the Company would be able to find suitable replacement
subcontractors. The Company's emphasis on maintaining low inventory may
exacerbate the effects of any shortage that may result from the use of
sole-source subcontractors during periods of tight supply or rapid order growth.
The Company's ability to respond to greater than anticipated market demand may
be constrained by the availability of SMT or PCB subcontracting services.
Further, various of the Company's subcontractors are located in international
locations that, while offering low labor costs, may present heightened process
control, quality control, political, infrastructure, transportation, tariff,
regulatory, legal, import, export, economic or supply risks.
DEPENDENCE ON GRAPHICS AND MULTIMEDIA ACCELERATOR MARKET
Sales of graphics and multimedia accelerator subsystems accounted for
greater than 80% and 65% of the Company's net sales in the first quarter of 1998
and 1997, respectively. Although the Company has introduced DVD and audio
subsystems, ISDN adapters and SCSI host bus adapters, and has entered the PC
modem and communications market through the acquisition of Supra Corporation,
graphics accelerator subsystems are expected to continue to account for a
majority of the Company's sales for the foreseeable future. A decline in demand
or average selling prices for graphics accelerator subsystems, whether as a
result of new competitive product introductions, price competition, excess
supply, widespread cost reduction, technological change, incorporation of the
products' functionality onto personal computer motherboards or otherwise, would
have a material adverse effect on the Company's sales and operating results.
MIGRATION TO PERSONAL COMPUTER MOTHERBOARDS
The Company's graphics and multimedia accelerator subsystems are
individual products that function within personal computers to provide
additional multimedia functionality. Historically, as a given functionality
becomes technologically stable and widely accepted by personal computer users,
the cost of providing such functionality is typically reduced by means of large
scale integration into semiconductor chips, which can be subsequently
incorporated onto personal computer motherboards. The Company expects that such
migration will not occur in a substantial way with 3D graphics or Intel's
accelerated graphics port (AGP) in the near term, although the Company
recognizes that such migration could occur with respect to the functionality
provided by some of the Company's current products. While the Company believes
that a market will continue to exist for add-in subsystems that provide advanced
or multiple functions and offer flexibility in systems configuration, such as 3D
graphics, 3D audio, MPEG-2 digital video, high-speed I/O and modems, there can
be no assurance
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that the incorporation of new multimedia functions onto personal computer
motherboards or into CPU microprocessors, such as under Intel's MMX or AGP
technologies, will not adversely affect the future market for the Company's
products. In large part, the continuation of a robust market for add-in graphics
and video subsystems may depend on the timing and market acceptance of 3D
graphics and digital video MPEG-2 acceleration. This, in turn, may depend on the
availability of compelling 3D and MPEG-2 content, including games and
entertainment, broadcast digital video, PC video phones, desktop video
conferencing, and digital video, audio and VRML on the Internet. Similarly, the
robustness of the modem market may depend largely on the widespread adoption of
56Kbps and digital subscriber line (xDSL) technologies in both client-side
modems attached to the PC and server-side modems provided by Internet Service
Providers and telephone network central offices. The timing of major technology
introductions and the market acceptance of these new technologies and standards
are largely out of the control of the Company.
RISKS ASSOCIATED WITH RECENTLY ANNOUNCED ACQUISITION
In addition to the risks described under "-Management of Growth," the
Company faces significant risks associated with its proposed acquisition of
Micronics Computers, Inc. ("Micronics"). There can be no assurance that the
Company will realize the benefits of this transaction. In order to successfully
integrate Micronics, the Company must, among other things, retain key personnel;
integrate, from an engineering, manufacturing and sales and marketing
perspective, the acquired business into the Company's overall operations; and
consolidate excess facilities. The diversion of the attention of management from
the day-to-day operations of the Company, or difficulties encountered in the
integration process, could have a material adverse effect on the Company's
operating results. See Note 6 of Notes to Consolidated Condensed Financial
Statements.
COMPETITION
The market for the Company's products is highly competitive. The Company
competes directly against a large number of suppliers of graphics and multimedia
accelerator products for the PC such as Matrox Graphics Inc., STB Systems Inc.
and ATI Technologies Inc., and indirectly against PC systems OEMs to the extent
that they manufacture their own add-in subsystems or incorporate on PC
motherboards the functionality provided by the Company's products. In certain
markets where the Company is a relatively new entrant, such as modems, sound
cards and SCSI host adapters, the Company may face dominant competitors
including 3Com (modems), Creative Technology (sound cards) and Adaptec (SCSI
host bus adapters). In addition, the Company's markets are expected to become
increasingly competitive as multimedia functions continue to converge and
companies that previously supplied products providing distinct functions (for
example, companies today primarily in the sound, fax/modem, telephony, digital
signal processing, central processing unit or motherboard markets) emerge as
competitors across broader or more integrated product categories.
In addition, manufacturers of chipsets or other components used in the
Company's products could become future competitors of the Company to the extent
that such manufacturers elect to integrate forward into the add-in subsystem or
value-added software market, or as such multimedia chipset manufacturers provide
increasingly higher quality and more sophisticated software to their chipset
customers, including subsystem suppliers competitive to the Company. Also,
certain of the Company's current and potential competitors have significantly
greater market presence, name recognition and financial and technical resources
relative to the Company, and many have long-standing market positions and
established brand names in their respective markets. In addition, certain of the
Company's current and potential competitors also have a competitive cost
advantage as a result of being located in areas that impose significantly lower
taxes than the United States or offer a substantially lower cost of labor or
provide governmental subsidies, such as research and development and training
funds. Many of the Company's current and potential competitors also design and
manufacture their own graphics acceleration, video, sound, fax/modem or other
multimedia processing chipsets. While the Company believes that its
semiconductor vendor flexibility enables it to select, within certain limits,
from among the most advanced and price competitive chipsets available on the
open market, the captive semiconductor operations of certain of the Company's
current and potential competitors could provide them with significant
advantages, including greater control over semiconductor architecture and
technology, component design, component performance, systems and software
design, availability and cost.
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<PAGE> 21
The Company also believes that the strategy of certain of its current and
potential competitors is to compete largely on the basis of price, which may
result in significant price competition and lead to lower margins for the
Company's products or otherwise adversely affect the market for the Company's
products. To the extent that semiconductor availability is relatively robust and
software drivers and reference hardware designs from multimedia chipset
manufacturers are of high quality and sophistication, then competitors who sell
such reference designs and compete largely on price with little valued added
engineering may have a competitive cost or expense advantage relative to the
Company. There can be no assurance that the Company will be able to continue to
compete successfully in its current and future markets, or will be able to
compete successfully against current and new competitors, as the Company's
technology, markets and products continue to evolve.
DISTRIBUTION RISKS
The Company sells its products through a network of domestic and
international distributors, and directly to major retailers/mass merchants, VARs
and OEM customers. The Company's future success is dependent on the continued
viability and financial stability of its customer base. The computer
distribution and retail channels historically have been characterized by rapid
change, including periods of widespread financial difficulties and consolidation
and the emergence of alternative sales channels, such as direct mail order,
telephone sales by PC manufacturers and electronic commerce on the World Wide
Web. The loss of, or reduction in, sales to certain of the Company's key
customers as a result of changing market conditions, competition, or customer
credit problems could have a material adverse effect on the Company's operating
results. Likewise, changes in distribution channel patterns, such as increased
commerce on the Internet, increased use of mail-order catalogues, increased use
of consumer-electronics channels for personal computer sales, or increased use
of channel assembly to configure PC systems to fit customers' requirements could
affect the Company in ways not yet known. Moreover, additions to or changes in
the types of products the Company sells, such as the introduction of
professional-grade products or the migration toward more communications-centric
products, may require specialized value-added reseller channels, relations with
which the Company has only begun to establish.
Inventory levels of the Company's products in the two-tier distribution channels
used by the Company ("Channel Inventory Levels") generally are maintained in a
range of one to three months of customer demand. These Channel Inventory Levels
tend toward the low end of the months-of-supply range when demand is stronger,
sales are higher and products are in short supply. Conversely, when demand is
slower, sales are lower and products are abundant, then Channel Inventory Levels
tend toward the high end of the months-of-supply range. Frequently, in such
situations, the Company attempts to ensure that distributors devote their
working capital, sales and logistics resources to the Company's products to a
greater degree than to those of competitors. Similarly, the Company's
competitors attempt to ensure that their own products are receiving a
disproportionately higher share of the distributors' working capital and
logistics resources. In an environment of slower demand and abundant supply of
products, price declines are more likely to occur and, should they occur, are
more likely to be severe. Further, in such an event, high Channel Inventory
Levels may result in substantial price protection charges. Such price protection
charges have the effect of reducing net sales and gross profit. Consequently,
the Company, in taking steps to bring its Channel Inventory Levels down to a
more desirable level, may cause a shortfall in net sales during one or more
accounting periods. This situation may also result in price protection charges
as prices are decreased, having an adverse impact on operating results. While
the Company believes that its Channel Inventory Levels for many of its products
are appropriate at this time, there are certain products which have a Channel
Inventory Level that is higher than desirable. The Company accrues for potential
price protection on unsold channel inventory. However, there can be no assurance
that any estimates, reserves or accruals will be sufficient or that any future
price reductions will not have a material adverse effect on operating results,
including during the second quarter of 1998.
PRODUCT RETURNS; PRICE PROTECTION
The Company frequently grants limited rights to customers to return
certain unsold inventories of the Company's products in exchange for new
purchases ("Stock Rotation"), as well as price protection on unsold inventory.
Moreover, certain of the Company's retail customers will readily accept returned
product from their own retail customers, and these returned products are, in
turn, returned to the Company for credit. The Company estimates returns and
accrues for potential price protection on unsold channel inventory. The Company
expects
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significant price protection charges due to the transition from PCI to AGP-based
graphics accelerators and from SGRAM to SDRAM-based graphics accelerators during
the second quarter of 1998. However, there can be no assurance that any
estimates, reserves or accruals will be sufficient or that any future returns or
price reductions will not have a material adverse effect on operating results,
including through the mechanisms of Stock Rotation or price protection,
particularly in light of the rapid product obsolescence which often occurs
during product transitions. The short product life cycles of the Company's
products, the evolving markets for new multimedia and connectivity technologies
such as the new 56 Kbps modem and 3D graphics technologies, and the difficulty
in predicting future sales through the distribution channels to the final end
customer all increase the risk that new product introductions, price reductions
by the Company or its competitors, or other factors affecting the personal
computer and add-in subsystems industry could result in significant and
unforeseen product returns, with such returns creating a material adverse effect
on the Company's financial performance. In addition, there can be no assurance
that new product introductions by competitors or other market factors, such as
the integration of graphics acceleration or modem connectivity by OEMs onto
system motherboards, will not require the Company to reduce prices in a manner
or at a time that gives rise to significant price protection charges and has a
material adverse impact upon the Company's gross margins.
Furthermore, the markets that the Company serves include end users who buy
from computer retail and consumer electronics mass merchant outlets to upgrade
their existing PCs. Such customers frequently decide to return products to the
retail outlets from which they earlier purchased the product. Such returns are
made for a variety of reasons, including the customer changing his or her mind
regarding his or her purchase decision, the customer has difficulty with the
installation or use of the product, the product does not offer the features,
functions, or performance that the customer expected or the customer experiences
incompatibilities between the product and his or her existing PC hardware or
software. Since many of the products that the Company sells incorporate advanced
computer technology, the Company expects that end-user customer returns,
including warranty returns, will be a continuing negative attribute of the PC
installed-base upgrade market. There can be no assurance that the Company will
be able to achieve gross margins in the PC installed-base upgrade market that
will be high enough to offset the expenses of end-user customer returns and
still generate an acceptable return on sales to the Company.
OEM CUSTOMER RISKS
The Company currently has a limited number of OEM customers. While the
Company is seeking to increase its sales to OEMs, certain OEMs maintain internal
add-in subsystem design and manufacturing capabilities or have long-standing
relationships with competitors of the Company, and there can be no assurance
that the Company will be successful in its efforts to increase its OEM sales.
Moreover, developing supplier relationships with major PC systems OEMs and
installing the processes, procedures and controls required by such OEMs can be
an expensive and time-consuming process, and there can be no assurance that the
Company will achieve an acceptable financial return on this investment. Further,
to the extent that PC systems OEM's selection criteria are weighted toward
multimedia subsystem suppliers that have their own captive SMT manufacturing
operations, then the Company's sole reliance on outside SMT subcontract
manufacturers may be a negative factor in winning such PC systems suppliers' OEM
contracts.
It is expected that OEM revenue will carry a lower gross margin percentage
compared to sales to other channels due to perceived lower expenses to support
such OEM revenue and the buying power exercised by large OEMs. Furthermore, many
large OEMs require that distribution hubs be established local to their
factories to supply such factories on very short notice. Such hubs represent a
cash drain on the Company to support the required inventory, and a product
obsolescence and inventory write-off risk as the price of such inventory may
decline or reach the end of its useful life or design-in life before such
inventory, which may be specific to a certain OEM, is completely consumed. The
Company's contractual relationship with Dell Computer Corporation may represent
such a product obsolescence and inventory write-off risk.
The Company's products are priced for and generally aimed at the higher
performance and higher quality segment of the market. Therefore, to the extent
that OEMs focus on low-cost solutions rather than high-performance solutions, an
increase in the proportion of the Company's sales to OEMs may result in an
increase in the proportion of the Company's revenue that is generated by
lower-selling-price or lower-gross-margin
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<PAGE> 23
products, particularly with respect to the Company's audio and modem products,
which could adversely affect future gross margins and operating results of the
Company.
RAPID TECHNOLOGICAL CHANGE
The markets for the Company's products are characterized by rapidly
changing technology, evolving industry standards, frequent new product
introductions and rapid product obsolescence. For example, 3D technology is
evolving rapidly in the graphics and audio markets, memory architectures and
speeds are changing rapidly, and DVD and MPEG-2 decryption techniques and
navigation technologies are still being refined. Product life cycles in the
Company's markets frequently range from six to twelve months. The Company's
success will be substantially dependent upon its ability to continue to develop
and introduce competitive products and technologies on a timely basis with
features and functionalities that meet changing customer requirements in a
cost-effective manner. Further, if the Company is successful in the development
and market introduction of new products, it must still correctly forecast
customer demand for such new products so as to avoid either excessive unsold
inventory or excessive unfilled orders related to the products. The task of
forecasting such customer demand is unusually difficult for new products, for
which there is little sales history, and for indirect channels, where the
Company's customers are not the final end customers. Moreover, whenever the
Company launches new products, it must also successfully manage the corollary
obsolescence and price erosion of those of its older products that are impacted
by such new products, as well as any resulting price protection charges and
Stock Rotations from its distribution channels. In the second quarter of 1998,
the Company expects to face product technology cycle challenges in the
PCI-to-AGP graphics bus transition, the SGRAM-to-SDRAM memory architecture
transition and the K56flex to V.90 modem protocol transition.
RISKS OF INTERNATIONAL SALES
The Company's international sales are subject to a number of risks
generally associated with international business operations, including the
effect on demand for the Company's products in international markets as a result
of a strengthening or weakening U.S. dollar, the effect of currency fluctuations
on consolidated multinational financial results, any state-imposed restrictions
on the repatriation of funds, any import and export duties and restrictions,
certain international economic conditions, the expenses, time and technical
resources required to localize the Company's various products and to support
local languages, the logistical difficulties of managing multinational
operations and dispersed product inventory designed or manufactured to meet
specific countries' requirements, and the delays and expenses associated with
homologating the Company's telecommunications products and securing the
necessary governmental approvals for shipment to various countries.
The Company's international sales can also be affected if inventory sold
by the Company to its international distributors and OEMs and held by them or
their customers does not sell through to final end customers, which may impact
international distributor or OEM orders in the succeeding periods. The Company
believes that it generally has less information with respect to the inventory
levels held by its international OEMs and distributors as compared to their
domestic counterparts, and that the supply chain to such international customers
is longer, and that therefore the Company generally has less visibility on how
this held inventory might affect future orders to and sales by the Company. In
the event that international OEMs or distributors change their desired inventory
levels, there can be no assurance that the Company's net sales to such customers
will not decline at such time or in future periods, or that the Company will not
incur price protection charges with respect to such customers.
INFORMATION TECHNOLOGY AND TELECOMMUNICATIONS SYSTEMS
The Company is currently making significant investments in establishing
systems, processes and procedures to more efficiently and effectively manage its
worldwide business and enable communications and data sharing among its
employees and various business units. This effort comprises a significant
investment of expense and capital funds, as well as a drain on management
resources, for the installation of information technology ("IT") and
telecommunications equipment and IT applications. As part of this program to
install IT systems throughout the Company, management has begun installation of
an enhanced enterprise-wide business management,
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resource planning and decision support application. Further, in order to more
effectively manage the Company's business and avert Year 2000 issues, the
Company is implementing this new ERP application and the associated IT equipment
in order for it to be fully operational no later than by the beginning of 1999.
Such an effort is expected to comprise a further substantial investment of
expenses and management resources by the Company.
YEAR 2000 COMPLIANCE
Many existing computer systems and applications, and other control
devices, use only two digits to identify a year in the date field, without
considering the impact of the upcoming change in the century. As a result, such
systems and applications could fail or create erroneous results unless corrected
so that they can process data related to the year 2000. The Company relies on
its systems, applications and devices in operating and monitoring all major
aspects of its business, including financial systems (such as general ledger,
accounts payable and payroll modules), customer services, infrastructure,
embedded computer chips, networks and telecommunications equipment and end
products. The Company also relies, directly and indirectly, on external systems
of business enterprises such as customers, suppliers, creditors, financial
organizations, and of governmental entities, both domestic and international,
for accurate exchange of data. The Company's current estimate is that the costs
associated with the year 2000 issue, and the consequences of incomplete or
untimely resolution of the year 2000 issue, will not have a material adverse
effect on the result of operations or financial position of the Company in any
given year. However, despite the Company's efforts to address the year 2000
impact on its internal systems, the Company has not fully identified such impact
or whether it can resolve it without disruption of its business and without
incurring significant expense. In addition, even if the internal systems of the
Company are not materially affected by the year 2000 issue, the Company could be
affected through disruption in the operation of the enterprises with which the
Company interacts. See "--Information Technology and Telecommunications
Systems."
CAPITAL NEEDS
There can be no assurance that additional capital beyond the amounts
currently forecasted by the Company will not be required or that any required
additional capital will be available on reasonable terms, if at all, at such
time or times as required by the Company. Any shortfall in capital resources
compared to the Company's level of operations or any inability to secure
additional capital as needed could impair the Company's ability to finance
inventory, accounts receivable and other operational needs. Such capital
limitations could also impair the Company's ability to invest in research and
development, improve customer service and support, deploy information technology
systems, and expand manufacturing and other operations. Failure to keep pace
with competitive requirements in any of these areas could have a material
adverse effect on the Company's business and operating results. Moreover, any
need to raise additional capital through the issuance of equity securities may
result in additional dilution to earnings per share.
PROPRIETARY RIGHTS
While the Company had 4 issued U.S. Patents and 18 pending U.S. Patent
Applications at March 31, 1998, it nonetheless relies primarily on a combination
of trademark, copyright and trade secret protection together with licensing
arrangements and nondisclosure and confidentiality agreements to establish and
protect its proprietary rights. There can be no assurance that the Company's
measures to protect its proprietary rights will deter or prevent unauthorized
use of the Company's technology, brand or other proprietary or intellectual
property. In addition, the laws of certain foreign countries may not protect the
Company's proprietary rights to the same extent as do the laws of the United
States or the EC. As is typical in its industry, the Company from time to time
is subject to legal claims asserting that the Company has violated the
proprietary rights of third parties. In the event that a third party was to
sustain a valid claim against the Company, and any required licenses were not
available on commercially reasonable terms, the Company's operating results
could be materially and adversely affected. Litigation, which could result in
substantial cost to and diversion of the resources of the Company, may also be
necessary to enforce proprietary rights of the Company or to defend the Company
against claimed infringement of the proprietary rights of others.
STOCK PRICE VOLATILITY
The trading price of the Company's Common Stock has been subject to
significant fluctuations to date, and could be subject to wide fluctuations in
the future in response to quarter-to-quarter variations in operating results,
announcements of technological innovations, new products or significant OEM
systems design wins by the Company or its competitors, general conditions in the
markets for the Company's products or the computer industry, the price and
availability of purchased components, general financial market conditions,
market conditions for PC or semiconductor stocks, changes in earnings estimates
by analysts, or other events or factors. In this regard, the Company does not
endorse and accepts no responsibility for the estimates or recommendations
issued by stock research analysts from time to time. In addition, the public
stock markets in general, and technology stocks in particular, have experienced
extreme price and trading volume volatility. This volatility has significantly
affected the market prices of securities of many high technology companies for
reasons frequently unrelated to the operating performance of the specific
companies. These broad market fluctuations may adversely affect the market price
of the Company's Common Stock.
DEPENDENCE ON KEY PERSONNEL
The Company's future success will depend to a significant extent upon the
efforts and abilities of its senior management and professional, technical,
sales and marketing personnel. The competition for such personnel is intense,
particularly in the San Jose, California area ("Silicon Valley"). There can be
no assurance that the Company will be successful in retaining its existing key
personnel or in attracting and retaining the additional
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key personnel that it requires. The loss of services of one or more of its key
personnel or the inability to add or replace key personnel could have a material
adverse effect on the Company. The salary, performance bonus and stock option
packages necessary to recruit or retain key personnel, particularly in Silicon
Valley, may significantly increase the Company's expense levels or result in
dilution to the Company's earnings per share. The Company does not carry "key
person" life insurance on any of its employees.
LEGAL MATTERS
The Company has been named as a defendant in several putative class action
lawsuits which were filed in June and July, 1996 and June, 1997 in the
California Superior Court for Santa Clara County and the U.S. District Court for
the Northern District of California. Certain executive officers and directors of
the Company are also named as defendants. The plaintiffs purport to represent a
class of all persons who purchased the Company's Common Stock between October
18, 1995 and June 20, 1996 (the "Class Period"). The complaints allege claims
under the federal securities laws and California law. The plaintiffs allege that
the Company and the other defendants made various material misrepresentations
and omissions during the Class Period. The complaints do not specify the amount
of damages sought. The Company believes that it has good defenses to the claims
alleged in the lawsuits and will defend itself vigorously against these actions.
These cases are in the early stages and no trial date has been set. The ultimate
outcome of these actions cannot be presently determined. Accordingly, no
provision for any liability or loss that may result from adjudication or
settlement thereof has been made in the accompanying consolidated financial
statements.
The Company is also party to other claims and pending legal proceedings
that generally involve employment and patent issues. These cases are, in the
opinion of management, ordinary and routine matters incidental to the normal
business conducted by the Company. In the opinion of management, the ultimate
disposition of such proceedings will not have a materially adverse effect on the
Company's consolidated financial position or future results of operations.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company has been named as a defendant in several putative class action
lawsuits which were filed in June and July 1996 and June 1997 in the California
Superior Court for Santa Clara County and the U.S. District Court for the
Northern District of California. Certain executive officers and directors of the
Company are also named as defendants. The plaintiffs purport to represent a
class of all persons who purchased the Company's Common Stock between October
18, 1995 and June 20, 1996 (the "Class Period"). The complaints allege claims
under the federal securities laws and California law. The plaintiffs allege that
the Company and the other defendants made various material misrepresentations
and omissions during the Class Period. The complaints do not specify the amount
of damages sought. The Company believes that it has good defenses to the claims
alleged in the lawsuits and will defend itself vigorously against these actions.
These cases are in the early stages and no trial date has been set. The ultimate
outcome of these actions cannot be presently determined. Accordingly, no
provision for any liability or loss that may result from adjudication or
settlement thereof has been made in the accompanying consolidated financial
statements.
The Company is also party to other claims and pending legal proceedings
that generally involve employment and trademark issues. These cases are, in the
opinion of management, ordinary and routine matters incidental to the normal
business conducted by the Company. In the opinion of management, the ultimate
disposition of such proceedings will not have a materially adverse effect on the
Company's consolidated financial position or future results of operations.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibit
Exhibit # Description of Document
--------- -----------------------
10.27 Line of Credit Agreement between the
Registrant and Imperial Bank dated
January 23, 1998.
27.1 Financial Data Schedule
B. Reports on Form 8-K
The Company did not file any reports on Form 8-K during the
quarter ended March 31, 1998.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DIAMOND MULTIMEDIA SYSTEMS, INC.
Date: May 14, 1998 /s/ William J. Schroeder
------------------------------------------
William J. Schroeder
President and Chief Executive Officer
Date: May 14, 1998 /s/ James M. Walker
------------------------------------------
James M. Walker
Senior Vice President and
Chief Financial Officer
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INDEX TO EXHIBITS
Exhibit
Number Description
- ------- -----------
10.27 Line of Credit Agreement between the Registrant
and Imperial Bank dated January 23, 1998.
27.1 Financial Data Schedule
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EXHIBIT 10.27
LOAN AGREEMENT
THIS LOAN AGREEMENT is entered into as of January 23, 1998 (this "Loan
Agreement") between DIAMOND MULTIMEDIA SYSTEMS, INC., a Delaware corporation
(herein called "Borrower"), and IMPERIAL BANK (herein called "Bank").
1. COMMITMENT.
A. COMMITMENT. Subject to all the terms and conditions of this Loan
Agreement and prior to the termination of its commitment as hereinafter
provided, Bank hereby agrees to make loans (each a "Loan" and collectively,
"Loans") to Borrower, in such amounts as Borrower shall request pursuant to this
Section 1.A., at any time from the date hereof through January 21, 1999 (the
"Maturity Date"), in an aggregate principal amount not to exceed $15,000,000.00
(the "Commitment"). If at any time or for any reason, the outstanding principal
amount of the Loan Account (as hereinafter defined) is greater than the
Commitment, Borrower shall immediately pay to Bank, in cash, the amount of such
excess. Any commitment of Bank, pursuant to the terms of this Loan Agreement, to
make Loans shall expire on the Maturity Date, subject to Bank's right to renew
said commitment in its sole and absolute discretion at Borrower's request. Any
such renewal of said commitment shall not be binding upon Bank unless it is in
writing and signed by an officer of Bank. Provided that no Event of Default has
occurred and is continuing, all or any portion of the Loans advanced by Bank
which are repaid by Borrower shall be available for reborrowing in accordance
with the terms hereof. Borrower promises to pay to Bank the entire outstanding
principal balance (and all accrued unpaid interest thereon) of the Loan Account
on the Maturity Date.
(1) LOANS. The amount of each Loan made by Bank to Borrower
hereunder shall be debited to the loan ledger account of Borrower maintained by
Bank for the Commitment (herein called the "Loan Account") and Bank shall credit
the Loan Account with all loan repayments in respect thereof made by Borrower.
When Borrower desires to obtain a Loan, Borrower shall notify Bank (which notice
shall be signed by an officer of Borrower and shall be irrevocable) in
accordance with Section 2 hereof, to be received no later than 3:00 p.m. Pacific
time one (1) Banking Day before the day on which the Loan is to be made. Loans
may only be used for working capital purposes, the issuance of letters of
credit, or the purchase of foreign exchange futures contracts.
(a) LETTER OF CREDIT USAGE AND SUBLIMIT. Subject to the
availability of the Commitment and in reliance on the representations and
warranties of Borrower set forth herein, at any time and from time to time from
the date hereof through the Banking Day immediately prior to the Maturity Date,
Bank shall issue for the account of Borrower such standby and commercial letters
of credit ("Letters of Credit") as Borrower may request, which request shall be
made by delivering to Bank a duly executed letter of credit application on
Bank's standard form; provided, however, that the outstanding and undrawn
amounts under all such Letters of Credit (i) shall not at any time exceed
$15,000,000 and (ii) shall be deemed to constitute Loans for the purpose of
calculating availability under the Commitment. Unless Borrower shall have
deposited with Bank cash collateral in an amount sufficient to cover all undrawn
amounts under each such Letter of Credit and Bank shall have agreed in writing,
no Letter of Credit shall have an expiration date that is later than 90 days
after the Maturity Date. All Letters of Credit shall be in form and substance
acceptable to Bank in its sole discretion and shall be subject to the terms and
conditions of Bank's form application and letter of credit agreement. Borrower
will pay any standard issuance and other fees that Bank notifies Borrower will
be charged for issuing and processing Letters of Credit for Borrower.
(b) FOREIGN EXCHANGE USAGE AND SUBLIMIT. Subject to the
availability of the Commitment and in reliance on the representations and
warranties of Borrower set forth herein, at any time and from time to time from
the date hereof through the Banking Day immediately prior to the Maturity Date.
Bank shall arrange the purchase by Borrower of foreign exchange futures
contracts ("Exchange Contracts") as Borrower may request, which request shall be
made by delivering to Bank a duly executed exchange contract application on
Bank's standard form; provided, however, that the maximum aggregate notional
contract amount under all such Exchange Contracts shall not at any time exceed
$10,000,000; provided, further, that 10% of the maximum aggregate notional
contract amount under all such Exchange Contracts shall be deemed to constitute
outstanding Loans for the purpose of calculating availability under the
1.
<PAGE> 2
Commitment. Unless Borrower shall have deposited with Bank cash collateral in
an amount sufficient to cover all undrawn amounts under each such Exchange
Contract and Bank shall have agreed in writing, no Exchange Contract shall have
a due date that is later than the Maturity Date. All Exchange Contracts shall
be in form and substance acceptable to Bank in its sole discretion and shall be
subject to the terms and conditions of Bank's form exchange contract
application. Borrower will pay any standard issuance and other fees that Bank
notifies Borrower will be charged for issuing and processing Exchange Contracts
for Borrower. After and during the continuance of an Event of Default, Bank
may, in its sole and absolute discretion, terminate any or all of the Exchange
Contracts. Borrower agrees to indemnify and hold harmless Bank from and against
all loss, costs and expense associated with any such termination of any
Exchange Contract.
(2) INTEREST PAYMENTS ON LOANS. Except as otherwise provided in
the Interest Rate Addendum, Borrower further promises to pay to Bank from the
date of the advance of the initial Loan through the Maturity Date, on or before
the twenty-first (21st) day of each month, interest on the average daily unpaid
balance of the Loan Account during the immediately preceding month at a rate of
interest equal to the rate of interest which Bank has announced as its prime
lending rate ("Prime Rate"), which shall vary concurrently with any change in
the Prime Rate. Interest shall be computed at the above rate on the basis of
the actual number of days during which the principal balance of the Loan
Account is outstanding divided by 360, which shall for interest computation
purposes be considered one (1) year.
2. LOAN REQUESTS. Requests for Loans hereunder shall be in writing
duly executed by Borrower in a form satisfactory to Bank and shall contain a
certification setting forth the matters referred to in Section 1, which shall
disclose that Borrower is entitled to the amount and type of Loan being
requested. Bank is hereby authorized to charge Borrower's deposit account with
Bank for all sums due Bank under this Loan Agreement.
3. DELIVERY OF PAYMENTS. Payment to Bank of all amounts due hereunder
shall be made at its Santa Clara Valley Regional office, or at such other place
as may be designated in writing by Bank from time to time. If any payment date
fall on a day that is not a day that Bank is open for the transaction of
business ("Banking Day"), the payment due date shall be extended to the next
Banking Day.
4. LATE CHARGE. If any interest payment, principal payment or
principal balance payment required hereunder is not received by Bank on or
before ten (10) days from the date in which such payment becomes due, Borrower
shall pay to Bank, a late charge equal to the lesser of (a) five percent (5.0%)
of the amount of such unpaid payment, in addition to said unpaid payment or (b)
the maximum amount permitted to be charged by applicable law, until remitted to
Bank; provided, however, nothing contained in this SECTION 4, shall be
construed as any obligation on the part of Bank to accept payment of any past
due payment or less than the total unpaid principal balance of the Loan Account
following the Maturity Date. All payments shall be applied first to any late
charges due hereunder, next to accrued interest then payable and the remainder,
if any, to reduce any unpaid principal due under the Loan Account.
5. DEFAULT INTEREST. From and after the Maturity Date or such earlier
date as all sums owing under the Loan Account becomes due and payable by
acceleration or otherwise, or upon the occurrence of an Event of Default, at
the option of Bank all sums owing under the Loan Account shall bear interest
until paid in full at a rate equal to the lesser of (a) five percent (5.0%) per
annum in excess of the then applicable interest rate provided for in SECTION
1.A(2) hereof or (b) the maximum amount permitted to be charged by applicable
law, until all obligations hereunder are repaid in full or the Event of Default
is waived or cured to the satisfaction of Bank, as applicable.
6. DEFINITIONS. As used in this Loan Agreement and unless otherwise
defined herein, all initially capitalized terms shall have the meanings set
forth on EXHIBIT A attached hereto and incorporated herein by this reference.
7. REPRESENTATIONS AND WARRANTIES. Borrower represents and warrants to
Bank:
(a) That Borrower is a corporation, duly organized and existing
in the State of Delaware and is authorized and in good standing to do
business in the State of California. The execution, delivery and
performance of each of the Loan Documents are within Borrower's corporate
powers, have been duly authorized and are not in conflict with law or the
terms of any charter, by-law or other incorporation papers, or of any
indenture, agreement or undertaking to which Borrower is a party or by
which Borrower is bound or affected;
2.
<PAGE> 3
(b) Borrower has good title to its assets and the same are not subject
to any liens or encumbrances other than Permitted Liens;
(c) Any and all financial information submitted by Borrower to
Bank,whether previously or in the future, is and will be true and correct;
(d) There is no litigation or other proceeding pending or threatened
against or affecting Borrower, and Borrower is not in default with respect to
any order, writ, injunction, decree or demand of any court or other
governmental or regulatory authority except as disclosed in EXHIBIT B;
(e)(i) The consolidated balance sheets of Borrower dated as of September
30, 1997, and the related consolidated profit and loss statements for the fiscal
year then ended, copies of which have heretofore been delivered to Bank by
Borrower, and all other statements and data submitted in writing by Borrower to
Bank in connection with Borrower's request for credit are true and correct, and
said balance sheet and profit and loss statement accurately present the
financial condition of Borrower as of the dates thereof and the results of the
operations of Borrower for the period covered thereby, and have been prepared in
accordance with GAAP, (ii) since such dates, there have been no material adverse
changes in the financial condition of Borrower, and (iii) Borrower has no
knowledge of any liabilities, contingent or otherwise, which are not reflected
in said balance sheet, and Borrower has not entered into any special commitments
or substantial contracts which are not reflected in said balance sheet, other
than in the ordinary and normal course of its business, which may have a
Material Adverse Effect upon its financial condition, operations or business as
now conducted;
(f) If the Borrower has a pension, profit sharing or retirement plan
subject to ERISA, such plan has been and will continue to be funded in
accordance with its terms and otherwise complies with and continues to comply
with the requirements of ERISA;
(g) Borrower has no liability for any delinquent local, state or
federal taxes, and, if Borrower has contracted with any government agency, it
has no liability for renegotiation of profits; and
(h) Borrower, as of the date hereof, possesses all necessary
trademarks, trade names, copyrights, patents, patent rights, and licenses to
conduct its business as now operated, without any known conflict with valid
trademarks, trade names, copyrights, patents, patent rights and license rights
of others.
8. NEGATIVE COVENANTS. Borrower agrees that so long as any loans,
obligations or liabilities remain outstanding or unpaid to Bank or the
commitment of Bank hereunder is in effect, neither Borrower, nor any of its
subsidiaries ("Subsidiaries") will, without the prior written consent of Bank:
A. Make any substantial change in the character of its
business as now conducted;
B. Create, incur, assume or permit to exist any
Indebtedness other than loans from Bank except obligations now existing as
shown in the financial statements referenced in SECTION 7(g)(i), excluding those
being refinanced by Bank, and Permitted Indebtedness; or sell or transfer,
either with or without recourse, any accounts or notes receivable or any monies
due or to become due;
C. Create, incur, assume or permit to exist any mortgage,
pledge, encumbrance, lien or charge of any kind (including the charge upon
property at any time purchased or acquired under conditional sale or other
title retention agreement) upon any asset now owned or hereafter acquired by
it, other than Permitted Liens and liens in favor of Bank;
D. Sell, dispose of or grant a security interest in any
asset now owned or hereafter acquired by it, other than to Bank (other than the
disposing of such asset in the ordinary and normal course of its business as
now conducted or other assets which are obsolete or otherwise considered
surplus), or execute any financing statements covering any assets in favor of
any secured party or Person;
3.
<PAGE> 4
E. Make any loans or advances to any Person or other entity other
than in the ordinary and normal course of its business as now conducted
(provided that such loans or advances are not made to any Person or entity which
is controlled by or under common control with Borrower) or make any investment,
other than Permitted Investments, in the securities of any Person or other
entity other than the United States Government; provided, that Borrower may make
loans, investments or advances to its 100% owned subsidiaries not exceeding
$10,000,000 in the aggregate above existing amounts shown on the September 30,
1997 consolidating balance sheet;
F. Use the proceeds of any Loan to purchase or carry margin stock
(as defined in Regulation U of the Board of Governors of the Federal Reserve
system);
G. Purchase or otherwise acquire all or substantially all of the
assets or business of any Person or other entity; or liquidate, dissolve, merge
or consolidate, or commence any proceedings therefor; or, except in the ordinary
and normal course of its business as now conducted, sell (including, without
limitation, the selling of any property or other asset accompanied by the
leasing back of the same) any assets including any fixed assets, any property,
or other assets necessary for the continuance of its business as now conducted.
Notwithstanding the foregoing, Borrower may proceed with any acquisition, merger
or consolidation (as described above) for a total aggregate consideration of up
to $75,000,000 during the term of this agreement, provided that no more than
$20,000,000 of the acquisition price is paid in cash in any one transaction (or
$30,000,000 in the aggregate for all acquisitions, mergers, or consolidations
during the term of this Agreement), and (1) so long as no Event of Default has
occurred and is continuing or would exist after giving effect to such
transaction, and (2) Borrower is the surviving corporation, if applicable. In
the event that Bank approval is required under this subsection, Bank agrees to
respond in writing within three (3) business days of receipt of the written
request and information necessary to make a decision; and
H. Declare or pay any dividend or make any other distribution on any
of its capital stock now outstanding or hereafter issued or purchase, redeem or
retire any of such stock other than in dividends or distributions payable in
Borrower's or any such Subsidiary's capital stock, except for the repurchase of
up to $600,000 in any one fiscal year.
9. AFFIRMATIVE COVENANTS. Borrower affirmatively covenants that so long
as any loans, obligations or liabilities remain outstanding or unpaid to Bank
or the commitment of Bank hereunder is in effect, it will:
A. Furnish Bank from time to time such financial reports,
statements and information as Bank may reasonably request and inform Bank
immediately upon the occurrence of a material adverse change therein;
B. Promptly after the same are available, deliver to Bank copies of
all such proxy statements, financial statements and reports as Borrower shall
send to its shareholders, if any, and copies of all reports which Borrower may
file with the Securities Exchange Commission or any governmental authority at
any time substituted therefor;
C. Promptly notify Bank of any attachment or other legal process
levied against any of its Property and any information received by Borrower
relative thereto;
D. Reimburse Bank upon demand for any and all legal costs,
including reasonable attorneys' fees, and other expense incurred in collecting
any sums payable by Borrower under the Loan Account or any other obligation
secured hereby, enforcing any term or provision of this Loan Agreement or
otherwise or in the preparation and enforcement of any agreement relating
hereto;
E. Maintain public liability, property damage and workers'
compensation insurance and insurance on all its insurable property against fire
and other hazards with responsible insurance carriers to the extent usually
maintained by similar businesses;
F. In the event the unpaid balance of the Loan Account shall exceed
the maximum amount of outstanding loans to which Borrower is entitled under
SECTION 1 hereof, Borrower shall immediately pay to Bank for credit to the Loan
Account the amount of such excess;
4.
<PAGE> 5
G. Maintain and preserve all rights, franchises and other
authority adequate and necessary for the conduct of its business and maintain
and preserve its existence in the State of its incorporation and any other
state(s) in which Borrower conducts its business, except with respect to such
other state(s), as the failure to do so would not have a Material Adverse
Effect:
H. Maintain public liability, property damage and workers
compensation insurance and insurance on all its insurable property against fire
and other hazards with responsible insurance carriers to the extent usually
maintained by similar businesses. Borrower shall provide evidence of property
insurance in amounts and types acceptable to Bank, and certificates naming Bank
as a loss payee;
I. Pay and discharge, before the same becomes delinquent and
penalties accrue thereon, all taxes, assessments and governmental charges upon
or against it or any of its properties, and any of its other liabilities at any
time existing, except to the extent and so long as: (1) the same are being
contested in good faith and by appropriate proceedings in such manner as not to
cause any Material Adverse Effect or the loss of any right of redemption from
any sale thereunder; and (2) it shall have set aside on its books reserves
(segregated to the extent required by GAAP);
J. Maintain a standard and modern system of accounting in
accordance with GAAP on a basis consistently maintained; permit Bank's
representatives to have access to, and to examine its properties, books and
records at all reasonable times; provided that Bank shall use its best efforts
to not interfere with the conduct of Borrower's business;
K. Maintain its properties, equipment and facilities in good
order and repair;
L. Maintain its principal operating accounts and banking
activities with Bank; and
M. Promptly notify the Bank in writing of the occurrence of
any Event of Default hereunder or any event which upon notice and lapse of time
would be an Event of Default.
10. FINANCIAL COVENANTS AND INFORMATION. All financial covenants and
financial information referenced herein shall be interpreted and prepared in
accordance with GAAP as used in the United States of America applied on a basis
consistent with previous years. Compliance with the financial covenants shall be
calculated and monitored on a quarterly basis, except as shall be expressly
stated to the contrary, Borrower affirmatively covenants that so long as any
loans, obligations or liabilities remain outstanding or unpaid to Bank or any
commitment is outstanding hereunder, it will, on a consolidated basis:
A. At all times, maintain a Minimum Tangible Net Worth
(meaning all assets, excluding any value for goodwill, trademarks, patents,
copyrights, organization expense and other similar intangible items, less total
liabilities, plus long term Subordinated Debt) of not less than the sum of
[$ ] plus [ ] of net profit after tax plus [ ] of the proceeds of any
public stock offerings;
B. At all times maintain a Maximum Ratio of Total Liabilities
(meaning all liabilities, excluding long term Subordinated Debt) to Tangible Net
Worth (as defined in Section 10.A. hereof) not to exceed [ ];
C. At all times maintain a Minimum Quick Ratio (meaning all
cash plus Accounts divided by current liabilities plus [ ] of any outstanding
Letters of Credit) of not less than [ ];
D. Measured on a quarterly basis on the last day of each
fiscal quarter, have a minimum net profit of not less than $1.00;
E. As soon as it is available, but not later than forty-five
(45) days after and as of the end of each quarter, deliver to Bank an
internally-prepared consolidating financial statement consisting of a balance
sheet and profit and loss statement, in form satisfactory to Bank, all in
reasonable detail, and certified by an appropriate officer of Borrower, subject,
however, to year-end audit adjustments, and a Compliance Certificate in the form
of EXHIBIT C attached hereto and incorporated herein by this reference,
certified by an officer of Borrower;
5.
<PAGE> 6
F. As soon as it is available, but not later than
forty-five (45) days after and as of the end of the first three fiscal quarters
of each fiscal year, deliver to Bank a copy of Borrower's 10-Q report as filed
with the Securities Exchange Commission;
G. As soon as it is available, but not later than sixty
(60) days after the end of Borrower's fiscal year, deliver to Bank unqualified
copies of Borrower's consolidated financial statements together with changes in
financial position, all in reasonable detail and stating in comparative form the
figures as of the close of and for the previous fiscal year, audited by an
independent certified public accountant selected by Borrower but acceptable to
Bank, including Borrower's 10-K report as filed with the Securities Exchange
Commission.
H. Upon the reasonable request of Bank, deliver to Bank
current budgets, sales projections, operating plans and other financial exhibits
and information in form and substance satisfactory to Bank;
I. Upon any officer becoming aware, deliver immediately to
Bank written notice of an Event of Default or event which with notice or lapse
of time would constitute an Event of Default; and
J. Upon any officer becoming aware, deliver immediately to
Bank written notice of any pending or threatened litigation claiming, or
reasonably likely to result in damages against Borrower in an amount in excess
of $500,000.
11. LOAN FEE. In addition to any other amounts due, or to become
due, concurrent with the execution hereof, in connection with the Commitment,
Borrower shall deliver to Bank a loan fee in the amount of [ ].
12. DEFAULT AND REMEDIES. The occurrence of any one or more of the
following shall constitute an "Event of Default";
(a) Default be made in the payment of any obligation by Borrower under
any Loan Document;
(b) Except for any failure to pay as described in clause (a) above,
breach be made in any warranty, statement, promise, term or condition, contained
herein or in any other Loan Document and the same shall not have been cured to
the satisfaction of Bank within ten (10) days after Borrower shall have
received notice thereof or any Responsible Officer of Borrower became aware
thereof, whether by written notice from Bank, or otherwise; provided, that if
the default cannot by its nature be cured within the ten (10) day period or
cannot after diligent attempts by Borrower be cured within a reasonable time
then Borrower shall have an additional reasonable period (which shall not in any
case exceed thirty (30) days) to attempt to cure such default, and within such
reasonable time period the failure to have cured such default shall not be
deemed an Event of Default; provided further, that no cure period shall exist
for breaches in respect of Borrower's obligations under SECTION 8, SUBSECTIONS
9.A, 9.B, 9.C, 9.D, 9.F, 9.G, 9.H, 9.I and 9.L, and SECTION 10 of this Loan
Agreement); provided further, that no loans will be required to be made during
such cure period;
(c) Any statement, warranty or representation made by Borrower at any
time proves false;
(d) Borrower defaults in the repayment of any principal of or the
payment of any interest on any indebtedness exceeding in the aggregate principal
amount $500,000 or breaches or violates any term or provision of any promissory
note, loan agreement, mortgage, indenture or other evidence of such indebtedness
pursuant to which amounts outstanding in the aggregate exceed $500,000 if the
effect of such breach is to permit the acceleration of such indebtedness,
whether or not waived by the note holder or obligee, and such failure shall not
have been cured to Bank's satisfaction within fifteen (15) calendar days after
Borrower shall become aware thereof, whether by written notice from Bank or
otherwise, or there has in fact been an acceleration of such indebtedness;
(e) Borrower becomes insolvent or makes an assignment for the benefit
of creditors;
6.
<PAGE> 7
(f) Any proceeding be commenced by Borrower under any bankruptcy,
reorganization, arrangement, readjustment of debt or moratorium law or statute
or, any such a proceeding is commenced against Borrower and is not dismissed or
stayed within ten (10) days (provided that no Loans will be made prior to the
dismissal of such proceeding);
(g) Any money judgment, writ of attachment, garnishment, execution or
other legal process be entered against Borrower or issued against any material
Property of Borrower which is not fully covered by insurance (subject to
reasonable deductibles) and remains unvacated, unbonded, unstayed or unpaid or
undischarged for more than fifteen (15) days (whether or not consecutive) or in
any event later than five (5) days prior to the date of any proposed sale
thereunder, or if any assessment for taxes against Borrower other than against
any of its real property, is made by the Federal or State government or any
department thereof;
(h) The occurrence of a Termination Event with respect to any Pension
Plan if the aggregate liability of Borrower and its ERISA Affiliates under
ERISA as a result thereof, when added to the amount of all other such
liabilities incurred since the date hereof, exceeds $500,000;
(i) Any change in Borrower's financial condition, prospects or operations
which has a Material Adverse effect; or
(j) There shall occur a sale, transfer, disposition or encumbrance
(whether voluntary or involuntary), or an agreement shall be entered into to do
so, with any Person or group of Persons (as such terms are defined pursuant to
Federal securities laws) with respect to more than 20% of the issued and
outstanding capital stock of the Borrower and, as a result thereof, such Person
or group of Persons has the ability to direct or cause the direction of the
management and policies of the Borrower.
Upon the occurrence and during the continuance of an Event of Default, Bank
may, at its option and without demand or presentment first made and without
notice to Borrower, all of which are hereby expressly waived, do any one or more
of the following: (i) Terminate its obligation to make loans to Borrower as
provided in SECTION 1 hereof; or (ii) Declare all Indebtedness of Borrower to
Bank immediately due and payable. Bank shall have the right to enforce one or
more remedies hereunder successively or concurrently, and any such action shall
not estop or prevent Bank from pursuing any further remedy which it may have
hereunder or by law.
13. RECORDS RETENTION. Borrower authorizes Bank to destroy all invoices,
delivery receipts, reports and other types of documents and records submitted
to Bank in connection with the transactions contemplated herein at any time
subsequent to four (4) months from the time such items are delivered to Bank.
14. ATTORNEYS' FEES; EXPENSES. Borrower agrees to reimburse Bank for (i)
its reasonable attorneys' fees and expenses incurred in connection with the
negotiation, preparation, execution and delivery of the Loan Documents and (ii)
its reasonable out-of-pocket expenses incurred in connection with its due
diligence and closing of this Agreement.
15. GOVERNING LAW; JUDICIAL REFERENCE.
A. GOVERNING LAW. This Agreement shall be deemed to have been made in
the State of California and the validity, construction, interpretation, and
enforcement hereof, and the rights of the parties hereto, shall be determined
under, governed by, and construed in accordance with the internal laws of the
State of California, without regard to principles of conflicts of law.
B. JUDICIAL REFERENCE.
(1) Other than (a) nonjudicial foreclosure and all matters in
connection therewith regarding security interests in real or personal property;
or (b) the appointment of a receiver, or the exercise of other provisional
remedies (any and all of which may be initiated pursuant to applicable law),
each controversy, dispute or claim between the parties arising out of or
relating to this Loan Agreement or the other Loan documents, which controversy,
dispute or claim is not settled in writing within thirty (30) days after the
"Claim Date" (defined as the date on which a party subject to this Loan
Agreement gives written notice to all other parties that a controversy, dispute
or claim exists), will be settled by a
7.
<PAGE> 8
reference proceeding in California in accordance with the provisions of Section
638 et seq. of the California Code of Civil Procedure, or their successor
section ("CCP"), which shall constitute the exclusive remedy for the settlement
of any controversy, dispute or claim concerning this Loan Agreement, including
whether such controversy, dispute or claim is subject to the reference
proceeding and except as set forth above, the parties waive their rights to
initiate any legal proceedings against each other in any court or jurisdiction
other than the Superior Court in the County where the real property, if any, is
located or Santa Clara County, if none (the "Court"). The referee shall be a
retired Judge of the Court selected by mutual agreement of the parties, and if
they cannot so agree within forty-five (45) days after the Claim Date, the
referee shall be promptly selected by the Presiding Judge of the Court (or
his/her representative). The referee shall be appointed to sit as a temporary
judge, with all of the powers for a temporary judge, as authorized by law, and
upon selection should take and subscribe to the oath of office as provided for
in Rule 244 of the California Rules of Court (or any subsequently enacted
Rule). Each party shall have one peremptory challenge pursuant to CCP Section
170.6. The referee shall (x) be requested to set the matter for hearing within
sixty (60) days after the date of selection of the referee and (y) try any and
all issues of law or fact and report a statement of decision upon them, if
possible, within ninety (90) days of the Claim Date. Any decision rendered by
the referee will be final, binding and conclusive and judgement shall be
entered pursuant to CCP Section 644 in any court in the State of California
having jurisdiction. Any party may apply for a reference proceeding at any time
after thirty (30) days following notice to any other party of the nature of the
controversy, dispute or claim, by filing a petition for a hearing and/or trial.
All discovery permitted by this Loan Agreement shall be completed no later than
fifteen (15) days before the first hearing date established by the referee. The
referee may extend such period in the event of a party's refusal to provide
requested discovery for any reason whatsoever, including, without limitation,
legal objections raised to such discovery or unavailability of a witness due to
absence or illness. No party shall be entitled to "priority" in conducting
discovery. Depositions may be taken by either party upon seven (7) days written
notice, and request for production or inspection of documents shall be
responded to within ten (10) days after service. All disputes relating to
discovery which cannot be resolved by the parties shall be submitted to the
referee whose decision shall be final and binding upon the parties. Pending
appointment of the referee as provided herein, the Superior Court is empowered
to issue temporary and/or provisional remedies, as appropriate.
(2) Except as expressly set forth in this Loan Agreement, the
referee shall determine the manner in which the reference proceeding is
conducted including the time and place of all hearings, the order of
presentation of evidence, and all other questions that arise with respect to
the course of the reference proceedings. All proceedings and hearings conducted
before the referee, except for trial, shall be conducted without a court
reporter except that when any party so requests, a court reporter will be used
at any hearing conducted before the referee. The party making such a request
shall have the obligation to arrange for and pay for the court reporter. The
costs of the court reporter at the trial shall be borne equally by the parties.
(3) The referee shall be required to determine all issues in
accordance with existing case law and the statutory laws of the State of
California. The rules of evidence applicable to proceedings at law in the State
of California will be applicable to the reference proceedings. The referee shall
be empowered to enter equitable as well as legal relief, to provide all
temporary and/or provisional remedies and to enter equitable orders that will be
binding upon the parties. The referee shall issue a single judgment at the close
of the reference proceeding which shall dispose of all of the claims of the
parties that are the subject of the reference. The parties hereto expressly
reserve the right to contest or appeal from the final judgment or any appealable
order or appealable judgment entered by the referee. The parties hereto
expressly reserve the right to findings of fact, conclusions of laws, a written
statement of decision, and the right to move for a new trial or a different
judgment, which new trial, if granted, is also to be a reference proceeding
under this provision.
(4) In the event that the enabling legislation which provides for
appointment of a referee is repealed (and no successor statute is enacted), any
dispute between the parties that would otherwise be determined by the reference
procedure herein described will be resolved and determined by arbitration. The
arbitration will be conducted by a retired judge of the Court, in accordance
with the California Arbitration Act, Section 1280 through Section 1294.2 of the
CCP as amended from time to time. The limitations with respect to discovery as
set forth hereinabove shall apply to any such arbitration proceeding.
8.
<PAGE> 9
16. MISCELLANEOUS PROVISIONS.
A. Nothing herein shall in any way limit the effect of the
conditions set forth in any other security or other agreement executed by
Borrower, but each and every condition hereof shall be in addition thereto.
B. No failure or delay on the part of Bank, in the exercise of any
power, right or privilege hereunder shall operate as a waiver thereof, nor shall
any single or partial exercise thereof.
C. All rights and remedies existing under this Loan Agreement or any
other Loan Document are cumulative to, and not exclusive of, any rights or
remedies otherwise available.
D. All headings and captions in this Loan Agreement and any related
documents are for convenience only and shall not have any substantive effect.
E. This Loan Agreement may be executed in any number of
counterparts, each of which when so delivered shall be deemed an original, but
all such counterparts shall constitute but one and the same instrument. Each
such agreement shall become effective upon the execution of a counterpart hereof
or thereof by each of the parties hereto and telephonic notification that such
executed counterparts has been received by Borrower and Bank.
Bank: Borrower:
IMPERIAL BANK DIAMOND MULTIMEDIA SYSTEMS, INC.
By: /s/ KENNETH W. LE DEIT By: /s/ RONALD R. MATSUSHIMA
------------------------------ ----------------------------
Name: Kenneth W. Le Deit Name: Ronald R. Matsushima
Title: Assistant Vice President Title: Corporate Treasurer
LIST OF EXHIBITS AND SCHEDULES
EXHIBIT A: Definitions
SCHEDULE 1 TO EXHIBIT A: List of Specific Permitted Indebtedness
SCHEDULE 2 TO EXHIBIT A: List of Specific Permitted Investments
EXHIBIT B: Litigation
EXHIBIT C: Compliance Certificate
9.
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EXHIBIT A
DEFINITIONS
"ACCOUNTS" means any right to payment for goods sold or leased, or to be
sold or to be leased, or for services rendered or to be rendered no matter how
evidenced, including accounts receivable, contract rights, chattel paper,
instruments, purchase orders, notes, drafts, acceptances, general intangibles
and other forms of obligations and receivables.
"CAPITAL LEASE" means, as to any Person, any lease of any Property by such
person as lessee that is, or should be in accordance with Financing Accounting
Standards Board Statement No. 13, classified and accounted for as a "capital
lease" on the balance sheet of such Person prepared in accordance with GAAP.
"CAPITAL LEASE OBLIGATION" means, with respect to any Capital Lease, the
amount of the obligation of the lessee thereunder that, in accordance with GAAP,
would appear on a balance sheet of such lessee in respect of such Capital Lease
or otherwise be disclosed in a note to such balance sheet.
"CONTINGENT OBLIGATION" means, as applied to any Person, any direct or
indirect liability, contingent or otherwise, of that Person with respect to any
indebtedness, lease, dividend, letter of credit or other obligation of another,
including, without limitation, any such obligation directly or indirectly
guaranteed, endorsed (otherwise than for collection or deposit in the ordinary
course of business), co-made or discounted or sold with recourse by that Person,
or in respect of which that Person is otherwise directly or indirectly liable,
including, without limitation any such obligation for which that Person is in
effect liable through any agreement (contingent or otherwise) to purchase,
repurchase or otherwise acquire such obligation or any security therefor, or to
provide funds for the payment or discharge of such obligation (whether in the
form of loans, advances, capital stock purchases, capital contributions or
otherwise), or to maintain the solvency of the obligor of such obligation, or to
make payment for any products, materials or supplies or for any transportation,
services or lease regardless of the non-delivery or non-furnishing thereof, in
any such case if the purpose or intent of such agreement is to provide assurance
that such obligation will be paid or discharged, or that any agreements relating
thereto will be complied with, or that the holders of such obligation will be
protected (in whole or in part) against loss in respect thereof. The amount of
any Contingent Obligation of any Person shall be deemed to be an amount equal to
the maximum amount of such Person's liability with respect to the stated or
determinable amount of the primary obligation for which such Contingent
Obligation is incurred or, if not stated or determinable, the maximum reasonably
anticipated liability in respect thereof (assuming such Person is required to
perform thereunder).
"ERISA" means the Employee Retirement Income Security Act of 1974, and any
regulations issued pursuant thereto, as amended or replaced and as in effect
from time to time.
"ERISA AFFILIATE" means, with respect to any Person, any Person (or any
trade or business, whether or not incorporated) that is under common control
with that Person, within the meaning of Section 414 of the Internal Revenue Code
of 1986, as amended or replaced and as in effect from time to time.
"EVENT OF DEFAULT" has the meaning set forth in SECTION 12.
"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other Person as may be approved by the significant segment of the accounting
profession, which are applicable to the circumstances as of the date of
determination.
"INDEBTEDNESS" means, as to any Person, without duplication, (a) all
indebtedness of such Person for borrowed money, including, without limitation,
all of such indebtedness outstanding under this Loan Agreement and any of the
other Loan Documents, (b) all Capital Lease Obligations of such Person, (c) to
the extent of the outstanding indebtedness thereunder, any obligation of such
Person representing an extension of credit to such Person, whether or not for
borrowed money, (d) any obligation of such Person for the deferred purchase
price of Property or services (other than (i) trade or other accounts payable in
the ordinary course of business in accordance with customary industry terms and
(ii) deferred franchise
Exhibit A
Page 1 of 4
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fees), (e) all Contingent Obligations, (f) any obligation of such Person of the
nature described in clauses (a), (b), (c), (d) or (e) above, that is secured by
a Lien on assets of such Person and which is non-recourse to the credit of such
Person, but only to the extent of the fair market value of the assets so subject
to the Lien, (g) obligations of such Person arising under acceptance facilities
or under facilities for the discount of accounts receivable of such Person, (h)
any obligation of such Person to reimburse the issuer of any letter of credit
issued for the account of such Person upon which a draw has been made, and (i)
any lease having the effect of indebtedness, whether or not the same shall be
treated as such on the balance sheet of Borrower under GAAP.
"INTEREST RATE ADDENDUM" means that certain Libor and Competitive Rate
Addendum to Loan Agreement dated of even date herewith.
"LIEN" means any mortgage, pledge, security interest, lien or other
charge or encumbrance, including the lien or retained security title of a
conditional vendor, upon or with respect to any property or assets.
"LOAN ACCOUNT" has the meaning set forth in SECTION 1.A(1).
"LOAN DOCUMENTS" means this Loan Agreement, the Interest Rate Addendum,
and that certain Agreement to Provide Insurance (Real or Personal Property)
dated of even date herewith, each as executed by Borrower in favor of Bank,
together with all other documents entered into or delivered pursuant to any of
the foregoing, in each case as originally executed or as the same may from time
to time be modified, amended, supplemented or restated.
"LOANS" means individually and collectively, the Loans advanced pursuant
to SECTION 1.
"MATERIAL ADVERSE EFFECT" means any set of circumstances or events which
(a) has or could reasonably be expected to have any material adverse effect upon
the validity or enforceability of any material provision of any Loan Document,
(b) is or could reasonably be expected to be material and adverse to the
condition (financial or otherwise) or business operations of Borrower, (c)
materially impairs or could reasonably be expected to materially impair the
ability of Borrower, to perform its material Obligations, (d) materially impairs
or could reasonably be expected to materially impair the value of any material
assets of Borrower, or (e) materially impairs or could reasonably be expected to
materially impair the ability of Bank to enforce any of its legal remedies
pursuant to the Loan Documents.
"MATURITY DATE" has the meaning set forth in SECTION 1.A.
"PBGC" means the Pension Benefit Guaranty Corporation or any successor
thereof established under ERISA.
"PENSION PLAN" means any "employee pension benefit plan" that is subject
to Title IV of ERISA and which is maintained for employees of Borrower or any of
its ERISA Affiliates, other than a Multiemployer Plan.
"PERMITTED INDEBTEDNESS" means the following:
(1) indebtedness of Borrower or Indebtedness and Contingent
Obligations of its Subsidiaries in favor of Bank arising under this Loan
Agreement and the other Loan Documents;
(2) the existing Indebtedness and Contingent Obligations
disclosed on SCHEDULE 1 attached hereto and incorporated herein by this
reference; provided that the principal amount thereof is not increased
and the terms thereof are not modified to impose more burdensome terms
upon Borrower or any of its Subsidiaries;
(3) the Subordinated Debt;
(4) accrued dividends on the preferred stock of Borrower; and
(5) extensions, renewals, refinancings, modifications,
amendments and restatements of any indebtedness permitted under this
Loan Agreement, other than Indebtedness referred to in clause (3) above;
provided
Exhibit A
Page 2 of 4
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that the principal amount thereof is not increased or the terms thereof are not
modified to impose more burdensome terms upon Borrower.
"PERMITTED INVESTMENTS" means the investments listed in SCHEDULE 2 to EXHIBIT A.
"PERMITTED LIENS" means the following:
(i) liens for taxes, fees, assessments or other governmental charges
or levies, either not delinquent or being contested in good faith by
appropriate proceedings;
(ii) liens and security interests (a) upon or in any equipment
acquired or held by Borrower to secure the purchase price of such equipment or
indebtedness incurred solely for the purpose of financing the acquisition of
such equipment and in an amount not greater than the lesser of the purchase
price of such equipment or the fair market value of such equipment on the date
of the acquisition, or (b) existing on such equipment at the time of its
acquisition, provided that the lien and security interest is confined solely to
the property so acquired and improvements thereon, and the proceeds of such
equipment;
(iii) liens consisting of leases or subleases and licenses and
sublicenses granted to others in the ordinary course of Borrower's business not
interfering in any material respect with the business of Borrower and any
interest or title of a lessor or licensor under any lease or license, as
applicable;
(iv) liens securing claims or demands of materialmen, mechanics,
carriers, warehousemen, landlords and other like persons or entities imposed
without action of such parties, provided that the payment thereof is not yet
required;
(v) liens incurred or deposits made in the ordinary course of
Borrower's business in connection with worker's compensation, unemployment
insurance, social security and other like laws;
(vi) liens arising from judgments, decrees or attachments in
circumstances not constituting an Event of Default;
(vii) easements, reservations, rights-of-way, restrictions, minor
defects or irregularities in title and other similar charges or encumbrances
affecting real property not interfering in any material respect with the
ordinary conduct of Borrower's business;
(viii) liens in favor of customs and revenue authorities arising as a
matter of law to secure payment of customs duties in connection with the
importation of goods;
(ix) liens that are not prior to Bank's security interest which
constitute rights of set-off of a customary nature;
(x) any interest or title of a lessor in equipment subject to any
Capitalized Lease otherwise permitted hereunder; and
(xi) any liens arising from the filing or any financing statements
relating to true leases otherwise permitted hereunder.
"PERSON" means any individual, sole proprietorship, partnership, joint
venture, trust, unincorporated organization, association, corporation, limited
liability company, institution, public benefit corporation, firm, joint stock
company, estate, entity or governmental agency.
"PROPERTY" means any interest in any kind of property or asset, whether
real, personal or mixed, whether tangible or intangible.
Exhibit A
Page 3 of 4
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"SUBORDINATED DEBT" means indebtedness of Borrower, the repayment of
principal and interest of which is fully subordinated in time and right of
payment to the Loans, and has been approved in Bank's sole and absolute
discretion and in writing.
"TERMINATION EVENT" means (a) a "reportable event" as defined in
Section 4043 of ERISA (other than a "reportable event" that is not subject to
the provision for 30 day notice to the PBGC), (b) the withdrawal of Borrower or
any of its ERISA Affiliates from a Pension Plan during any plan year in which
it was a "substantial employer" as defined in Section 4001(a)(2) of ERISA, (c)
the filing of a notice of intent to terminate a Pension Plan or the treatment of
an amendment to a Pension Plan as a termination thereof pursuant to Section
4041 of ERISA, (d) the institution of proceedings to terminate a Pension Plan
by the PBGC or (e) any other event of condition which might reasonably be
expected to constitute grounds under ERISA for the termination of, or the
apportionment of a trustee to administer, any Pension Plan.
Exhibit A
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SCHEDULE 1 TO EXHIBIT A
SPECIFIC PERMITTED INDEBTEDNESS
1. $30,000,000 unsecured line of credit form Sanwa Bank.
2. [ ] unsecured line of credit from BHF Bank
3. [ ] unsecured line of credit to Borrower's subsidiary SPEA Software
GmbH from BHF Bank, guaranteed by Borrower
Schedule 1 to Exhibit A
Page 1 of 1
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SCHEDULE 2 TO EXHIBIT A
SPECIFIC PERMITTED INVESTMENTS
Investments made in accordance with Borrower's investment policy, provided that
Borrower's investment policy has been disclosed to and approved in advance by
Bank:
The following subsidiaries are 100% owned by Borrower:
1. Diamond Multimedia Systems International, Inc.
2. Diamond Multimedia Systems Limited
3. Diamond Multimedia Contract Services Limited
4. Diamond Multimedia Systems GmbH
5. Supra Corporation, Communications Division
6. Spea Software GmbH (subsidiary of Supra Corporation)
7. Diamond Multimedia Systems Service Company Limited
8. Diamond Multimedia Systems KK
9. Supra GmbH
10. Supra Corp. (Inactive)
11. Diamond Multimedia Systems SARL
12. Spea Software GmbH (Sub. of Supra GmbH not Supra Corp. USA)
13. Spea UK (inactive)
14. Diamond Multimedia Systems Pty Ltd. (Australia)
15. Diamond Multimedia Systems International Inc. (Barbados)
16. Diamond Multimedia Systems Korea, Inc.
17. Diamond Multimedia Systems, Inc. Hong Kong
18. Diamond Multimedia Systems, Inc. Singapore
Schedule 2 to Exhibit A
Page 1 of 1
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EXHIBIT B
LITIGATION
The Borrower has been named as a defendant in several putative class action
lawsuits which were filed in June and July, 1996 and June, 1997 in the
California Superior Court for Santa Clara County and the U.S. District Court for
the Northern District of California. Certain executive officers and directors of
the Borrower are also named as defendants. The plaintiffs purport to represent a
class of all persons who purchased the Borrower's Common Stock between October
18, 1995 and June 20, 1996 (the "Class Period"). The complaints allege claims
under the federal securities laws and California law. The plaintiffs allege
claims under the federal securities laws and California law. The plaintiffs
allege that the Borrower and the other defendants made various material
misrepresentations and omissions during the Class Period. The complaints do not
specify the amount of damages sought. The Borrower believes that it has good
defenses to the claims alleged in the lawsuits and will defend itself vigorously
against these actions.
The Borrower is also party to other claims and pending legal proceedings that
generally involve employment and trademark issues. These cases are, in the
opinion of management of the Borrower, ordinary and routine matters incidental
to the normal business conducted by the Borrower. In the opinion of management
of the Borrower, the ultimate disposition of such proceedings will not have a
materially adverse effect on the Borrower's consolidated financial position or
future results of operations.
Exhibit B
Page 1 of 1
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LIBOR AND COMPETITIVE RATE ADDENDUM
TO LOAN AGREEMENT
This Libor and Competitive Rate Addendum ("Addendum") is dated as of
January 23, 1998, and is by and between DIAMOND MULTIMEDIA SYSTEMS, INC.
("Borrower") and Imperial Bank ("Bank"). This Addendum amends and supplements
the Loan Agreement of even date herewith to which it is attached (the "Loan
Agreement") and forms a part of and is incorporated into the Loan Agreement.
In the event of any inconsistency between the terms herein and the terms
of the Loan Agreement, the terms herein shall in all cases govern and control.
All capitalized terms herein, unless otherwise defined herein, shall have the
meanings set forth in the Loan Agreement.
1. ADVANCES.
1.1 PRIME LOANS. Advances permitted pursuant to the terms of the Loan
Agreement or this Addendum which bear interest in relation to Bank's Prime Rate
shall be referred to herein as "Prime Loans" and each such advance shall be a
"Prime Loan." Each Prime Loan shall bear interest at an annual rate equal to
the Bank's Prime Rate. "Prime Rate" shall mean the rate of interest publicly
announced by Bank from time to time in Inglewood, California, as its prime rate
for lending. The Prime Rate is not intended to be the lowest rate of interest
charged by Bank in connection with extensions of credit to borrowers.
1.2 LIBOR LOANS. Advances permitted pursuant to the terms of the Loan
Agreement or this Addendum which bear interest in relation to the Libor Rate
shall be referred to herein as "Libor Loans" and each such advance shall be a
"Libor Loan." Each Libor Loan shall bear interest at the Libor Rate, as defined
below. A Libor Loan shall be in the minimum amount of [ ] or
such greater amount which is an integral multiple of Fifty Thousand Dollars
($50,000). No Libor Loan shall be made after the last Business Day that is at
least one (1) month prior to the Maturity Date described in the Loan Agreement.
1.3 COMPETITIVE RATE LOANS. Advances permitted pursuant to the terms of
the Loan Agreement or this Addendum which bear interest in relation to the
Competitive Rate shall be referred to herein as "Competitive Rate Loans" and
each such advance shall be a "Competitive Rate Loan." Each Competitive Rate
Loan shall bear interest at the Competitive Rate, as defined below. A
Competitive Rate Loan shall be in the minimum amount of [ ]
or such greater amount which is an integral multiple of Fifty Thousand Dollars
($50,000). No Competitive Rate Loan shall be made after the last Business Day
that is at least one (1) month prior to the Maturity Date described in the Loan
Agreement.
2. INTEREST ON FIXED RATE LOANS.
2.1 RATE OF INTEREST. Each Fixed Rate Loan shall bear interest on the
unpaid principal amount thereof from the Loan Date through the date paid
(whether by acceleration or otherwise) at a rate equal to (i) in the case of
Libor Loans, the sum of the Applicable Margin plus the Libor Rate for the
Interest Period or (ii) in the case of Fixed Rate Loans, the Competitive Rate
for the Interest Period. The "Applicable Margin" shall mean [ ] basis points
for borrowings under [ ] and [ ] basis points for borrowings of
and over.
(a) "Business Day" means any day on which Bank is open for
business in the State of California.
(b) "Competitive Rate" shall mean the rate quoted by Bank to
Borrower from time to time at Borrower's request, for money outstanding
for the particular specified period of [ ] days or less.
(c) "Competitive Rate Loan" shall mean any Loan which bears
interest at the Competitive Rate.
(d) "Fixed Rate Loan" shall mean, collectively, Libor Loans and
Competitive Rate Loans.
(e) "Governmental Regulation" means any (i) United States
Federal, state or foreign law or regulation (including without limitation
Regulation D); and (ii) the adoption or making of any interpretation,
application, directive or request applying to a class of lenders,
including Bank, of or under any United States Federal, state, or any
foreign law or
<PAGE> 18
regulation (whether or not having the force of law) by any court or by any
governmental, central banking, monetary or taxing authority charged with the
interpretation or administration of such law or regulation.
(f) "Interest Period" shall mean (i) in the case of a Libor
Loan, a period of [ ] months, commencing on the applicable Loan Date, as
selected by Borrower pursuant to Section 2.2 or (ii) in the case of a
Competitive Rate Loan, the interest period selected by Borrower which shall be
[ ] in duration; provided, however, that Borrower may not select an Interest
Period that would otherwise extend beyond the Maturity Date of the Loan.
Borrower may also select a twelve (12) month Interest Period for Libor Loans if
and when Bank notifies Borrower that such interest Period is available, as
determined by Bank in its sole discretion.
(g) "Libor Base Rate" shall mean with respect to any Interest
Period, the rate equal to the arithmetic mean (rounded upwards, if necessary, to
the nearest 1/16 of 1%) of:
(i) the offered rates per annum for deposits in U.S.
Dollars for a period equal to such Interest Period which appears at 11:00 a.m.,
London time, on the Reuters Screen LIBOR Page on the Business Day that is two
(2) Business Days before the first day of such Interest Period, in each case if
at least four (4) such offered rates appear on such page, or
(ii) if clause (i) is inapplicable, (x) the offered rate
per annum for deposits in U.S. Dollars for a period equal to such Interest
Period which appears as of 11:00 a.m., London time on the Telerate Monitor on
Telerate Screen 3750 on the Business Day which is two (2) Business Days before
the first day of such Interest Period; or (y) if clause (x) above is
inapplicable, the arithmetic mean (rounded upwards, if necessary, to the nearest
1/16 of 1%) of the interest rates per annum offered by at least three (3) prime
banks selected by Bank at approximately 11:00 a.m. London time, on the Business
Day which is two (2) Business Days before such date for deposits in U.S. Dollars
to prime banks in the London interbank market, in each case for a period equal
to such Interest Period in an amount equal to the amount to which the Libor Rate
applies.
(h) "Libor Loan" shall mean any Loan which bears interest at a
rate based upon the Libor Rate.
(i) "Libor Rate" shall mean, for the applicable Interest Period
for a Libor Loan, a rate per annum (rounded upwards, if necessary, to the
nearest 1/16 of 1%) equal to (i) the Libor Base Rate for such interest Period
divided by (ii) 1.00 minus the Reserve Requirement Rate (expressed as a decimal
faction) for such Interest Period.
(j) "Loan Date" shall mean the date on which a Fixed Rate Loan is
made, a Fixed Rate Loan is continued, or a Prime Loan is converted to a Fixed
Rate Loan.
(k) "Regulatory Change" means, with respect to Bank, any change
on or after the date of the Loan Agreement and this Addendum in any Governmental
Regulation, including the introduction of any new Governmental Regulation or the
rescission of any existing Governmental Regulation.
(l) "Reserve Requirement Rate" means, for any Interest Period,
the aggregate of the rates, effective as of the Business Day which is two (2)
Business Days before the first day of the Interest Period, at which:
(i) reserves (including any marginal, supplemental or
emergency reserves) are required to be maintained during such Interest Period
under Regulation D against "Eurocurrency liabilities" (as such term is used in
Regulation D) by member banks of the Federal Reserve System; and
(ii) any additional reserves are required to be maintained
by Bank by reason of any Regulatory Change against (x) any category of
liabilities which includes deposits by reference to which the Libor Rate is to
be determined as provided in the definition of "Libor Base Rate;" or (y) any
category of extensions of credit or other assets which include Libor Loans.
(m) "Reuters Screen LIBOR Page" means the display designated as
page LIBOR on the Reuters Monitor Money Rates Service or such other page as may
replace the LIBOR page on that service for the purpose of displaying London
interbank offered rates of major banks.
2.2 DETERMINATION OF INTEREST RATES. Subject to the terms and
conditions of the Loan Agreement and this Addendum, Borrower, at its option, may
request an advance in the form of a Fixed Rate Loan, a continuation of a Fixed
Rate Loan, or a conversion of a Prime Loan into a Fixed Rate Loan, only upon
delivery to Bank of an irrevocable written notice received by Bank
Page 2 of 6
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at least three (3) Business Days prior to the requested Loan Date, specifying
(i) the principal amount of such Fixed Rate Loan, (ii) the requested Loan Date,
and (iii) the selected Interest Period. Upon receiving such notice, Bank shall
determine (which determination shall be in accordance with SECTION 2.1 and
shall, absent manifest error, be final, conclusive and binding upon all parties
hereto) the Libor Rate or Competitive Rate, as the case may be, applicable to
such Fixed Rate Loan two (2) Business Days prior to the Loan Date, and shall
promptly give notice thereof (in writing or by telephone confirmed in writing)
to Borrower. If Borrower shall fail to notify Bank of its selected Interest
Period for a Libor Loan (including the continuation of an existing Libor Loan or
the conversion of a Prime Loan into a Libor Loan), the Borrower shall be deemed
to have selected an Interest Period of three (3) months.
2.3 INTEREST PAYMENT DATES. Accrued interest on Fixed Rate Loans shall be
due and payable in full on the last day of the Interest Period; provided,
however, that if the Interest Period is longer than ninety (90) days, then
interest will be due on a quarterly basis and on the last day of the relevant
Interest Period.
2.4 COMPUTATION OF INTEREST AND FEES. All computations of interest and
fees payable pursuant to the Loan Agreement shall be calculated on the basis of
a three hundred sixty (360) day year for the actual number of days elapsed (less
the date of repayment).
2.5 RECORDATION BY BANK. Bank is hereby authorized to record the Loan
Date, the applicable Interest Period, the principal amount, and the interest
rate of each Fixed Rate Loan made (or continued or converted) by Bank, and the
date and amount of each payment or prepayment of principal thereof, in Bank's
records. Any such recordation shall constitute prima facie evidence of the
accuracy of the information recorded; provided that the failure to make any
such recordation shall not in any way affect the Borrower's obligations
hereunder.
3. CONVERSION TO PRIME LOANS.
3.1 ELECTION BY BORROWER. Subject to all the terms and conditions of this
Addendum, Borrower may elect from time to time to convert a Fixed Rate Loan to
a Prime Loan by giving Bank at least three (3) Business Days' prior irrevocable
notice of such election, and any such conversion of a Fixed Rate Loan shall be
made on the last day of the Interest Period with respect thereto.
3.2 FAILURE OF NOTICE BY BORROWER. If Borrower otherwise fails to give
notice specifying its requests with respect to any Fixed Rate Loans that are
scheduled to become due, such failure shall be deemed, in the absence of any
notice from Borrower to the contrary, to be notice of a requested advanced in
the form of a Prime Loan in a principal amount equal to the amount of said
Fixed Rate Loan.
4. PREPAYMENTS.
4.1 VOLUNTARY PREPAYMENT BY BORROWER. Subject to the terms and conditions
of the Loan Agreement and this Addendum, Borrower may, upon at least three (3)
Business Days' irrevocable notice to Bank as provided herein, at any time and
from time to time on any Business Day prepay any Prime Loan or Libor Loan in
whole or in part, without penalty or premium, other than customary actual
"Breakage Fees" and "Prepayment Costs" as defined below, resulting from
prepayment of any Libor Loan prior to the expiration of the Interest Period
relating thereto; provided, however, that if Borrower prepays (including
voluntarily or mandatory prepayment, voluntary or mandatory conversion into a
Prime Loan, or acceleration) a Competitive Rate Loan prior to the last day of
the Interest Period of such Loan, Borrower shall pay on the date of such
prepayment, in addition to the outstanding principal amount of the Loan, an
amount equal to the Competitive Rate Loan Product (as defined below). The
"Competitive Rate Loan Product" shall mean the product of: (1) the principal
amount of the Loan; (2) the Prime Rate, and (3) the number of days in the
Interest Period divided by 360. The notice of prepayment shall specify the date
and amount of the prepayment, and the Loan to which the prepayment applies.
Each partial prepayment of a Libor Loan shall be in an amount not less than
Fifty Thousand Dollars ($50,000) or such greater amount which is an integral
multiple of Fifty Thousand Dollars ($50,000); provided, that unless a Libor
Loan is prepaid in full, no prepayment shall be made if, after giving effect to
such prepayment, the aggregate principal amount of Libor Loans having the same
Interest Period shall be less than One Million Dollars ($1,000,000). Notice of
prepayment having been delivered as aforesaid, the principal amount of the
prepayment specified in such notice shall become due and payable on the
prepayment date set forth in such notice. All payments of principal under this
Section 4 shall be accompanied by accrued but unpaid interest on the amount
being prepaid through the date of such prepayment.
4.2 BREAKAGE FEES. If for any reason (including voluntary or mandatory
prepayment, voluntary or mandatory conversion of a Libor Loan into a Prime
Loan, or acceleration), Bank receives all or part of the principal amount of a
Libor Loan prior to the last day of the Interest Period for such Loan, Borrower
shall immediately notify Borrower's account officer at Bank and, on demand
Page 3 of 6
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by Bank, pay Bank the Breakage Fees, defined as the amount (if any) by which (i)
the additional interest which would have been payable on the amount so received
had it not been received until the last day of such Interest Period exceeds (ii)
the interest which would have been recoverable by Bank (without regard to
whether Bank actually so invests said funds) by placing the amount so received
on deposit in the certificate of deposit markets or the offshore currency
interbank markets or United States Treasury investment products, as the case may
be, for a period starting on the date on which it was so received and ending on
the last day of such Interest Period at the interest role determined by Bank in
its reasonable discretion. Bank's determination as to such amount shall be
conclusive and final, absent manifest error.
4.3 PREPAYMENT COSTS. Borrower shall pay to Bank, upon the demand of
Bank, such other amount or amounts as shall be sufficient (in the sole good
faith opinion of Bank) to compensate it for any loss, costs or expense incurred
by it as a result of any prepayment by Borrower (including voluntary or
mandatory prepayment, voluntary or mandatory conversion of a LIBOR Rate Loan
into a Prime Loan, or prepayment due to acceleration) of all or part of the
principal amount of a LIBOR Rate Loan prior to the last day of the Interest
Period for such Loan (including without limitation any failure by Borrower to
borrow a LIBOR Rate Loan on the Loan Date for such borrowing specified in the
relevant notice of borrowing hereunder). Such costs shall include, without
limitation, any interest or fees payable by Bank to lenders of funds obtained by
it in order to make or maintain its loans based on the London interbank
eurodollar market. Bank's determination as to such costs shall be conclusive and
final, absent manifest error.
5. REMEDIES UPON EVENTS OF DEFAULT.
5.1 CONVERSION TO PRIME LOANS. If any Event of Default has occurred
and is continuing under the Loan Agreement or this Addendum, then in addition to
all other remedies available to Bank under the Loan Agreement, at the option of
Bank and without demand or notice, all Fixed Rate Loans then outstanding shall
be automatically converted to Prime Loans on the last day of each respective
Interest Period for each Fixed Rate Loan.
5.2 INDEMNITY. Borrower agrees to pay and indemnify Bank for, and to
hold Bank harmless from, any and all cost, loss or expense (including without
limitation any such cost, loss or expense arising from interest or fees payable
by Bank to lenders of funds obtained by it in order to maintain its Fixed Rate
Loans hereunder, or in its reemployment of funds obtained in connection with the
making or maintaining of Fixed Rate Loans) which Bank may sustain or incur as a
consequence of any default by Borrower in connection with or related to: (a)
payment of the principal amount of or interest on Fixed Rate Loans, (b) making a
borrowing or conversion of a Fixed Rate Loan after Borrower has given a notice
thereof in accordance with this Addendum, or (c) making a prepayment of a Fixed
Rate Loan after Borrower has given a notice thereof in accordance with this
Addendum, or any prepayment (whether optional or mandatory) of any Fixed Rate
Loan prior to the end of the applicable Interest Period for such Loan.
6. ADDITIONAL PROVISIONS REGARDING FIXED RATE LOANS.
6.1 LIBOR RATE TAXES. All payments of principal, interest, fees,
costs, expenses and all other amounts payable to Borrower pursuant to the Loan
Agreement and this Addendum shall be made free and clear of and without
reduction by reason of all present and future income, stamp and other taxes or
other charges whatsoever imposed, assessed, levied or collected by any national
government or any political subdivision or taxing authority thereof or any
organization of which it is a member (excluding (i) any taxes imposed on or
measured by the overall net income or gross receipts of Bank by any such entity,
and (ii) any taxes which would have been imposed even if no provisions for Libor
Loans had appeared in this Addendum) (collectively, "Libor Taxes").
If any Libor Taxes are required to be withheld from any amounts payable
to Bank, Borrower shall pay such additional amounts as may be necessary so as to
yield to Bank a net amount equal to the total amount of the payments provided
for in this Addendum or under the Loan Agreement which Bank would have received
if such amounts had not been subject to Libor Taxes.
If any Libor Taxes are payable directly by Borrower, they shall be paid
by Borrower prior to the date on which penalties attach for failure to timely
pay such Libor Taxes. Within forty five (45) days after the date on which
payment of any such Libor Taxes is due pursuant to applicable law, Borrower will
furnish Bank the original receipt for the full payment of such Libor Taxes or,
if such is not available, evidence of such payment satisfactory in form and
substance to Bank. Borrower shall indemnify and hold Bank harmless against, and
will reimburse to Bank, upon demand, any incremental taxes, interest or
penalties that may become payable by Bank as a result of any failure by Borrower
to pay any Libor Taxes when due.
6.2 INABILITY TO DETERMINE FAIR INTEREST RATE. If at any time Bank,
in its sole and absolute discretion, determines that: (i) the amount of the
Libor Loans for periods equal to the corresponding Interest Periods are not
available to Bank in the offshore currency interbank markets, (ii) the Libor
Rate does not accurately reflect the cost to Bank of lending the Libor Loan, or
(iii) by
Page 4 of 6
<PAGE> 21
reason of any changes arising after the date of the Loan Agreement affecting the
London interbank eurodollar market, adequate and fair means do not exist for
ascertaining the applicable interest rate on the basis provided for in SECTIONS
2.1 and 2.2 above, then Bank shall promptly give notice thereof to Borrower.
Upon the giving of such notice, Bank's obligation to make Libor Loans shall
terminate, unless Bank and the Borrower agree in writing to a different interest
rate applicable to Libor Loans, or until such time as Bank notifies Borrower
that the circumstances giving rise to Bank's notice no longer exist. While such
circumstances continue to exist, (x) any requested Libor Loan shall be treated
as a request for a Prime Loan, (y) any Prime Loan that was to have been
converted to a Libor Loan shall be continued as a Prime Loan, and (z) any
outstanding Libor Loan shall be converted retroactively, on the first day of the
then current Interest Period with respect thereto, to a Prime Loan.
6.3 ILLEGALITY OR IMPRACTICABILITY. If (i) due to any Governmental
Regulation it shall become unlawful for Bank to continue to Fund or maintain any
Libor Loans, or to perform its obligations hereunder, or (ii) due to any
contingency occurring after the date of the Loan Agreement which has a material
adverse effect on the London interbank eurodollar market, it has become
impracticable for Bank to continue to Fund or maintain any Libor Loans, or to
perform its obligations hereunder, then Bank shall promptly give notice thereof
to Borrower. Upon the giving of such notice, Bank's obligation to make Libor
Loans shall terminate, and in such event, (x) any requested Libor Loan shall be
treated as a request for a Prime Loan, (y) any Prime Loan that was to have been
converted to a Libor Loan shall be continued as a Prime Loan, and (z) any
outstanding Libor Loan shall be converted retroactively, on the first day of the
then current Interest Period with respect thereto, to a Prime Loan.
6.4 GOVERNMENTAL REGULATIONS; INCREASED COSTS. Borrower shall pay to Bank,
within 15 days after demand by Bank, from time to time such amounts as Bank may
determine to be necessary to compensate it for any increased costs incurred by
Bank that Bank determines are attributable to its making or maintaining of any
Libor Loans to Borrower (such increases in costs and reductions in amounts
receivable being herein called "Additional Costs"), in each case resulting from
any Regulatory Change which:
(a) imposes a new tax or changes the basis of taxation of any amounts
payable to Bank under the Loan Agreement or this Addendum in respect of any
Libor Loans (other than changes which affect taxes measured by or imposed on the
overall net income of Bank by the jurisdiction in which such Bank has its
principal office); or
(b) imposes or modifies any reserve, special deposit or similar
requirements relating to any extensions of credit or other assets of, or any
deposits or other liabilities with or for the account of Bank (including any
Libor Loans or any deposits referred to in the definition of Libor Based Rate);
or
(c) imposes any other condition affecting the Loan Agreement (or any
of such extensions of credit or liabilities); or
(d) imposes or modifies a Governmental Regulation regarding capital
adequacy which has or would have the effect of reducing the rate of return on
capital of Bank or any person or entity controlling Bank ("Parent") as a
consequence of its obligations hereunder to a level below that which Bank (or
its Parent) could have achieved but for such adoption, change or compliance
(taking into consideration its policies with respect to capital adequacy) by an
amount deemed by Bank to be material.
Bank will notify Borrower of any event occurring after the date of the Loan
Agreement which will entitle Bank to Additional Costs pursuant to this SECTION
6.4 as promptly as practicable after it obtains knowledge thereof and determines
to request such compensation. Bank will furnish Borrower with a statement
setting forth the basis and amount of such request by Bank for Additional Costs
under this SECTION 6.4. Determinations and allocations by Bank for purposes of
this SECTION 6.4 of the effect of any Regulatory Change on its costs of
maintaining its obligations to make Libor Loans or of making or maintaining
Libor Loans or on amounts receivable by it in respect of Libor Loans, and of the
additional amounts required to compensate Bank in respect of any Additional
Costs, shall be conclusive and final, absent manifest error.
Page 5 of 6
<PAGE> 22
This Addendum is executed as of the date first written above.
BORROWER BANK
DIAMOND MULTIMEDIA SYSTEMS, INC. IMPERIAL BANK
a Delaware corporation a California banking corporation
By /s/ RONALD R. MATSUSHIMA By /s/ KENNETH W. LE DEIT
---------------------------------- ----------------------------------
Its Corporate Treasurer Its AVP
---------------------------------- ----------------------------------
Page 6 of 6
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